Financial system inquiry Prudential Regulation Authority 4 APRA’s response to the Interim Report...

response to the interim report

F i n a n c i a l sy st e m i n q u i ry

AustrAliAn prudentiAl regulAtion Authority

26 August 2014

Australian Prudential Regulation Authority 1

Contents

Glossary 2

APRA’s response to the Interim Report 4

Response to specific issues raised in the Interim Report 8

Chapter 2 of the Interim Report: Competition 8

Chapter 3 of the Interim Report: Funding 19

Chapter 4 of the Interim Report: Superannuation 27

Chapter 5 of the Interim Report: Stability 33

Chapter 6 of the Interim Report: Consumer outcomes 58

Chapter 7 of the Interim Report: Regulatory architecture 59

Chapter 8 of the Interim Report: Retirement income 75

Chapter 9 of the Interim Report: Technology 80

Chapter 10 of the Interim Report: International integration 81


Glossary

ADI Authorised deposit-taking institution

ANAO Australian National Audit Office

AOFM Australian Office of Financial Management

APRA Australian Prudential Regulation Authority

APRA Act Australian Prudential Regulation Authority Act 1998

ASIC Australian Securities and Investments Commission

ATO Australian Taxation Office

Banking Act Banking Act 1959

Basel Committee Basel Committee on Banking Supervision

Basel I

Basel Committee 1988, International convergence of capital

measurement and capital standards, July, and Basel Committee 1996,

Overview of the amendment to the capital accord to incorporate

market risks, January

Basel II

Basel Committee 2006, International Convergence of Capital

Measurement and Capital Standards. A Revised Framework —

Comprehensive Version, June

Basel III capital

Basel Committee 2010, Basel III: A global regulatory framework

for more resilient banks and banking systems, December

(revised June 2011)

Basel III liquidity Basel Committee 2013, Basel III: The Liquidity Coverage Ratio and

liquidity risk monitoring tools, January

CET1 Common Equity Tier 1

CFR Council of Financial Regulators

CLF Committed Liquidity Facility

Corporations Act Corporations Act 2001

D-SIB Domestic systemically important bank

FCS Financial Claims Scheme

FSAP Financial Sector Assessment Program

FSB Financial Stability Board

G-SIB Global systemically important bank

IAIS International Association of Insurance Supervisors

IMF International Monetary Fund

Insurance Act Insurance Act 1973

IRB Internal ratings-based

IRRBB Interest rate risk in the banking book

LCR Liquidity coverage ratio

LGD Loss-given-default

Life Insurance Act Life Insurance Act 1995


LMI Lenders mortgage insurance

LVR Loan-to-valuation ratio

NSFR Net Stable Funding Ratio

PPF Purchased payment facility

RBA Reserve Bank of Australia

RFC Registered financial corporation

RIS Regulation Impact Statement

RMBS Residential mortgage-backed security

RSE Registrable Superannuation Entity

SCCI Specialist Credit Card Institution

SIFI Systemically important financial institution

SIS Act Superannuation Industry (Supervision) Act 1993

SMSF Self-managed superannuation fund

SOE Statement of Expectations

SOI Statement of Intent

Wallis Inquiry Commonwealth of Australia 1997, Financial System Inquiry


APRA’s response to the Interim Report

The Financial System Inquiry’s Interim Report sets

out a diverse set of observations and policy

options. In this submission, the Australian

Prudential Regulation Authority (APRA)

responds to those most relevant to APRA and

its mandate, with the intention of providing

further information and perspectives to aid

the Inquiry as it proceeds to develop its

final recommendations.

APRA agrees with many of the Inquiry’s initial

observations. In particular, APRA welcomes the

Interim Report’s observations that:

the current regulatory model has proven

robust and effective;

regulatory mandates and powers are generally

well defined and Australia’s regulatory

coordination mechanisms have been strong;

the strong prudential framework, together

with a proactive approach to supervision,

contributed to Australia’s resilience during the

global financial crisis;

in the post-crisis period regulators have

applied the global reform framework in a

manner and timeframe to best suit Australian

market circumstances;

strong, independent financial regulators

are crucial to the efficient, stable,

fair and accessible operation of the financial

system; and

to be able to perform their roles effectively,

regulators need to be able to attract and

retain suitably skilled and experienced staff.

Overall, the Interim Report indicates that

Australia’s current regulatory model has served

Australia well and notes that, while submissions

have not called for significant change, there is

scope for improvement across a number of areas.

Many of the challenges the Inquiry has set out to

examine, such as the problem of ‘too big to fail’,

are longstanding and complex. This submission is

therefore intended to help identify advantages and

disadvantages of various options. The submission

also highlights that a number of areas examined by

the Inquiry are interdependent, and each cannot

be viewed in isolation.

In developing its vision for a financial system,

including associated regulatory arrangements, it is

important that the Inquiry bears in mind that the

Australian financial system has already

experienced a significant period of change. Both

regulators and the regulated industry need time

for these changes to be fully embedded, and for

their benefits to be realised. Stability of policy

settings and, where appropriate, simplification

should be important goals, to minimise

unnecessary costs arising from the need to assess

fundamental structural changes or revised

regulatory requirements.

APRA’s responses to key issues raised in the

Interim Report are summarised below, with

references to APRA’s initial submission where

appropriate. Detailed responses on specific

questions and policy options of most relevance to

APRA are provided in the second part of

this submission, presented in the order in

which they appear in the ten chapters of the

Interim Report.


Financial system stability

APRA welcomes the Inquiry’s conclusion that

Australia’s prudential framework has held the

Australian financial system in good stead.

APRA supports broadly maintaining the current

calibration of the framework, which it considers to

be at the more conservative end of the global

spectrum but not unduly so. Australia has been

among the leaders in adopting the post-crisis

international reform programme and this has

ultimately benefited both industry and the

Australian public by providing investors, both

domestic and international, with confidence

that Australian financial institutions are

fundamentally sound. The cost of any lack of

confidence would be significant.

The Interim Report points out that ongoing

compliance with international minimum standards

is important for maintaining the international

market access and competitiveness of Australian

institutions. At the same time, there are important

reasons why APRA should, and does, exercise a

degree of discretion in establishing appropriate

prudential requirements in an Australian

context. In implementing the post-crisis reforms,

APRA has been sensitive to domestic conditions

and policy objectives.

The Interim Report discusses the desire to promote

cross-border comparability in prudential ratios, but

this needs to be viewed against the primary goals

of ensuring Australian institutions have adequate

capital, and that the regulatory framework

provides appropriate incentives for prudent risk

management. Additional disclosures may help

provide greater transparency, particularly in

relation to the impact of APRA’s policy choices,

and APRA would support these. Most importantly,

however, markets and rating agencies clearly

understand that Australian authorised deposit-

taking institutions (ADIs) are well capitalised.

It is not evident that the current reporting

of capital ratios leads to any material

impact on access to, or cost of, funding for

Australian ADIs.

The additional capital required by domestic

systemically important banks (D-SIBs), which will

apply to the major Australian banks from 2016, is a

relatively new prudential tool and has been

established taking into account the full suite of

prudential requirements imposed by APRA. The

calibration of the D-SIB capital surcharge will be

monitored by APRA, having regard to future

industry and international developments. Other

proposals ultimately put forward by this Inquiry,

including those in relation to competitive issues

and financial stability, may also impact the

appropriate level for D-SIB capital requirements.

APRA’s prudential supervision of individual

institutions not only protects the interests of

depositors, policyholders and superannuation fund

members, but also supports financial stability.

Existing tools, supervisory processes and

coordination mechanisms are adequate to address

industry-level risks to financial stability: there

seems little need for new instruments designed

purely for macroprudential purposes, particularly

as these tools are untested and the purpose for

which they might need to be used is unclear.

The recent financial crisis demonstrated the

importance of being able to quickly and effectively

deal with failing financial institutions; where this

could not be achieved, problems were significantly

exacerbated. Strengthening APRA’s resolution

powers is an important and low-cost means of

helping to address these concerns. Some

modifications to the ADI Financial Claims Scheme

could also be made to simplify its operation

without undermining its effectiveness.


The Interim Report is appropriately concerned with

the perception of an implicit government

guarantee for the largest institutions, or those

perceived to be too big to fail. While this

perception may be mitigated somewhat by

providing greater clarity regarding the

circumstances in which private-sector stakeholders

will bear losses should a large bank need to be

restructured or recapitalised, achieving this

objective while maintaining financial stability will

not be easy. APRA welcomes the Inquiry’s support

for exploring practical approaches that may be

appropriate for Australia. However, given many of

these proposals are new and untested, a degree of

caution is warranted in proceeding too

quickly to firm recommendations ahead of

international developments.

Competition

The Interim Report considers whether there is

scope for ADI capital requirements to facilitate

greater competition between large and small ADIs,

particularly in relation to housing lending. As noted

in APRA’s initial submission to the Inquiry,

although a differential does exist, it is considerably

narrower than that suggested by a simple

comparison of headline risk weights.

Nevertheless, the size of the differences that have

emerged between the ADIs that use advanced

credit risk modelling versus standardised methods

to calculate capital requirements is currently the

subject of review internationally. There is

scepticism that modelled capital requirements are

sufficiently conservative across the global banking

system. This process ultimately is likely to

generate policy proposals that will increase capital

required for ADIs that use advanced modelling

approaches for residential mortgages and other

credit exposures. The Basel III leverage ratio will

also reduce the benefit received by the large ADIs

by effectively imposing a floor on the average risk

weight across their portfolios.

More broadly, APRA is not supportive of policy

proposals that would further increase the incentive

for ADIs to provide housing finance over other

forms of lending.

Superannuation and retirement

incomes

The Interim Report discusses the important

role of superannuation within the financial system,

its regulatory structure and options for better

supporting the post-retirement phase.

Superannuation would benefit from policy stability

to build long-term confidence and trust in the

system and encourage long-term savings. It is

critical, however, that there is holistic

consideration of the policy settings in both the

pre-retirement and post-retirement phases of the

system so that a coherent, sustainable and stable

retirement income policy framework, that is

suitably flexible and principles-based, is able to be

established and effectively implemented.

Longevity risk is a major risk for the sustainability

of retirement income systems around the world.

Changes to the superannuation regulations and the

Age Pension means test to remove impediments to

issuing products such as deferred lifetime annuities

are desirable. However they are unlikely, on their

own, to address all of the underlying reasons for

the current and historic low level of demand for

longevity protection products. The ability of the

private sector to offer attractive longevity risk

products will depend, among other things, on the

extent of risk sharing between retirees and

product providers, the availability of reinsurance

or other risk transfer mechanisms, access to long-

dated securities and the ability to adequately price

longevity risk.

The Interim Report put forward the option of

aligning regulation of APRA-regulated

superannuation trustees and funds with that of

responsible entities and registered managed

investment schemes. APRA firmly supports the

status quo. There were sound reasons for

establishing the current regulatory approach

at the time of the Wallis Inquiry – including the

compulsory nature of superannuation savings,

the lack of effective choice for a large

proportion of members, the long-term nature

of superannuation and the contribution of

superannuation to tax revenue forgone –

and these features remain prominent.


The Inquiry’s focus on the efficiency of the

superannuation sector and its costs and fees

is appropriate. Assessment of the efficiency of the

superannuation sector must, however, be framed

in terms of the ultimate outcomes achieved for

members. For any given pattern of contributions,

members’ outcomes are driven primarily by

investment performance, but insurance and other

benefit design aspects, fees, costs, taxes and the

form and timing of benefits taken by members are

also relevant considerations. It is important to take

into account all of these factors when making

comparisons with other jurisdictions.

APRA agrees with the Inquiry’s view that it is too

early to assess whether the MySuper reforms will

achieve their objectives, including in reducing

industry costs and fees. A review to assess the

effectiveness of the MySuper regime would most

appropriately be undertaken in a few years’ time

to allow a sufficient period for the reforms to be

fully implemented.

Regulatory independence and

accountability

APRA welcomes the Inquiry’s support for the

importance of regulator independence, including

for APRA, and fully acknowledges that

independence must be accompanied by strong

and effective accountability mechanisms. As noted

in its initial submission, APRA has substantial

independence from Government in most

respects but, over time, this has been eroded by

constraints on its prudential, operational and

financial flexibility.

APRA would therefore strongly support

mechanisms that move it to a more autonomous

budget and funding process, thereby enhancing

APRA’s operational independence and ability to

conduct efficient forward planning for its

operations. A more autonomous funding process

would need to be accompanied by increased

accountability and transparency regarding how

APRA utilises its resources. APRA is committed to

exploring enhanced accountability mechanisms

that reinforce its independence while also

providing relevant stakeholders with greater

confidence that APRA is operating efficiently

and effectively.

To effectively perform its role, APRA needs to be

able to attract suitably skilled and experienced

staff. This is more difficult if APRA is unable to

maintain the relativities of its own employment

conditions with those of the financial sector, from

which APRA does the bulk of its recruitment. Any

enhanced budgetary process should be designed

with this in mind.


Response to specific issues raised in the Interim Report

Chapter 2 of the Interim Report: Competition

Regulatory capital requirements (page 2-11)

The Inquiry would value views on the costs, benefits and trade-offs of the following policy options

or other alternatives:

No change to current arrangements.

Assist ADIs that are not accredited to use IRB models in attaining IRB accreditation.

Increase minimum IRB risk weights.

Introduce a tiered system of standardised risk weights.

Lower standardised risk weights for mortgages.

Allow smaller ADIs to adopt IRB modelling for mortgages only.

The Inquiry seeks further information on the following area:

How could Government or APRA assist smaller ADIs attain IRB accreditation?

Under the internationally agreed Basel I capital

framework that was introduced by the Reserve

Bank of Australia (RBA) in 1988, loans for the

purpose of housing were assigned a 50 per cent risk

weight, which resulted in lower capital

requirements relative to other forms of lending.

This regime, with some minor refinements,

continued until the Basel II framework was

implemented by the Australian Prudential

Regulation Authority (APRA) in 2008. Under

Basel II, there are two methodologies for

determining risk weights:

a standardised approach, under which

authorised deposit-taking institutions (ADIs)

assign prescribed risk weights to particular

types of loans; or

with supervisory approval, an advanced

(internal model-based) approach under which

ADIs estimate the probability a customer will

default, the exposure at the time of default

and the loss-given-default (LGD), and input

these into a supervisory formula which

determines the relevant risk weight.

In developing the Basel II regime, the Basel

Committee on Banking Supervision (Basel

Committee) considered that, on average, banks

utilising the model-based approaches should

generate a slightly lower capital requirement than

would be determined under the standardised

approach. This was intended to provide incentives

for banks to invest in the necessary data capture,

risk analysis and risk management framework

requirements, which should have benefits to banks

more broadly than simply meeting regulatory

capital requirements. APRA’s implementation of

Basel II was consistent with this objective: relative

to Basel I, the overall outcome for Australian ADIs

using the standardised approach was a five per

cent reduction in total required capital and

between zero and ten per cent for ADIs accredited

to use the advanced approaches.


As detailed in APRA’s initial submission to the

Inquiry, the average risk weight for residential

mortgage exposures for ADIs using the standardised

approach is currently in the order of 39 per cent;

the comparable figure under the internal ratings-

based (IRB) approach is around 18 per cent.1 These

figures are, however, not directly comparable.

Standardised risk weights are, by their nature,

broad-brush representations of risk and are

designed to achieve an appropriate aggregate level

of capital for the ADI as a whole. IRB risk weights,

on the other hand, are far more granular; they

may be lower or higher than the standardised risk

weights, depending on the specific risk

characteristics of borrowers and the nature of the

ADI’s portfolio. The higher risk weight for

residential mortgage exposures for smaller ADIs

appropriately provides a buffer to cover risks

associated with their high degree of geographic or

product concentration and their relatively greater

business, strategic and credit concentration risks

compared with the larger, more diversified ADIs.

The larger ADIs are also subject to other capital

requirements that are not applied to ADIs using the

standardised approach. These additional

requirements include a mandatory capital charge

for interest rate risk in the banking book (IRRBB)

and, for the major banks, an additional capital

surcharge of one percentage point reflecting their

systemic importance.

Nevertheless, as presently calibrated,

the more risk-sensitive IRB approach generates, on

the whole, a lower capital requirement for

residential mortgage exposures than the

standardised approach. As noted above,

the differential is partly explained by risk,

and by the deliberate structure of incentives

within the framework. However, the benign

housing experience in Australia over a very

long period means that it is difficult to derive an

appropriately conservative calibration for the IRB

approach based on historical losses.

This requires continued vigilance as to the

robustness of risk estimation by ADIs using the IRB

approach. APRA has already reflected this concern

in its 20 per cent LGD floor for residential

mortgage exposures; a number of other

jurisdictions have, in more recent times,

1 APRA 2014, Financial System Inquiry Submission,

31 March, page 74.

implemented similar measures in response to

concerns about low IRB risk weights for residential

mortgage exposures.

The Interim Report seeks further information

regarding the potential for Government or

APRA to provide assistance to smaller ADIs in

attaining IRB accreditation. This could involve the

development of a central database of the

historical default experience across Australian ADIs

that would be available to the smaller

ADIs that may lack sufficient historical data.

Industry investment in a pooled credit loss

database facility (which could extend beyond

residential mortgage exposures to cover

other common types of credit) would be a

welcome development.

IRB accreditation is not, however, solely based on

sufficiency of data for approval of credit risk

models for regulatory capital purposes. Pooling of

default data may address data paucity issues, but

ADIs would still need to make, and maintain,

substantial investment in risk measurement and

modelling systems and controls including in

specialist staff skills, to ensure such models were

fit for purpose. Using the models within an ADI’s

own internal risk management, capital planning

and remuneration practices (the so-called ‘use

test’) is an important prerequisite for supervisory

accreditation. APRA would not accredit ‘black box’

models developed and maintained by parties other

than the ADI seeking accreditation and that were

not sufficiently understood by the ADI itself or

embedded into its risk management system.


It is important to note that, if smaller ADIs were to

successfully obtain approval for use of the IRB

approach for their credit portfolios, it is unlikely

that the average risk weight for residential

mortgage exposures for these ADIs would

automatically settle at the same level as that of

the major banks. As detailed above, the level of

geographic and product concentrations, and the

impact such concentrations have had on each ADI’s

default experience, would likely produce an

average risk weight higher than that of the larger,

more diversified ADIs.

An important feature of APRA’s advanced

modelling accreditation process is that ADIs

seeking accreditation to model one type of risk

(e.g. credit risk) must also seek accreditation for

all other types of risk. For the largest ADIs that use

the IRB approach for their credit portfolios, this

has involved accreditation to also use the

advanced approaches for IRRBB and operational

risk.2 This ‘all-in’ approach is designed to prevent

ADIs from ‘cherry picking’ the risks for use of the

advanced approaches. This could otherwise lead to

a situation in which ADIs only seek accreditation

for models where the capital requirement would

fall, but not for other risks where modelling

indicates risk is being underestimated. APRA also

favoured the all-in approach to foster improved

risk management and risk measurement practices

across all material risks facing ADIs.

This all-in approach is not followed universally in

other jurisdictions. In particular, the modelling of

operational (i.e. non-financial) risk is often not a

requirement for IRB accreditation. Operational risk

can be particularly difficult to model, especially

for smaller ADIs; it is considerably more

challenging than modelling credit-related risks.

APRA is open to reconsidering whether to maintain

the requirement that ADIs must model non-

financial (i.e. operational) in addition to financial

(credit and market) risks as a condition to be

accredited to use the IRB approach. APRA

considers it appropriate to await further

international developments, including potential

revisions to the standardised approach to

operational risk, before committing to change the

current framework.

2 These ADIs already had accredited models for traded

market risk.

Beyond separating broad classes of risk, however,

the Basel framework does not allow for the

selective implementation of the IRB approach

across individual credit portfolios. This stance is

critical for protecting against cherry picking; it

would also undermine the ability of ADIs to

demonstrate they meet the use test. APRA has

always made clear that in order to achieve

accreditation to use the IRB approach, ADIs needed

to have commensurately stronger and more

sophisticated risk management and governance

across all of their activities. Cherry picking

portfolios for use of the IRB approach runs contrary

to the underlying conceptual approach.

Other options canvassed in the Interim Report

involve changes to risk weights under the

standardised approach, which would be contrary to

the Basel framework. There is no compelling

reason to adopt policy changes that are weaker

than the internationally agreed Basel framework in

an attempt to address competitive concerns.

Indeed, as noted in the Interim Report, ‘[t]he

Inquiry considers it appropriate for Australia to

maintain its compliance with the global standards,

such as the Basel framework for banking’.3

Furthermore, it is undesirable to make changes to

the prudential framework that would provide

further incentives for residential mortgage finance

over other forms of credit.

The Interim Report suggests that ‘standardised risk

weights do not provide incentives for the ADIs that

use them to reduce the riskiness of their lending’.4

This is not the case in Australia: a simple tiered

system of risk weights already exists. By way of

example, consider a standard residential mortgage

loan with no mortgage insurance. If the loan-to-

valuation ratio (LVR) is greater than 90 per cent,

the loan receives a 75 per cent risk weight. Capital

requirements decrease by one third (i.e. to a 50

per cent risk weight) if the LVR is reduced below

90 per cent and by a further third (i.e. to a 35 per

cent risk weight) if the LVR is reduced below 80

per cent. There are also incentives for ADIs to

obtain mortgage insurance; in general, risk weights

for higher LVR loans are reduced by around one-

quarter if mortgage insurance is obtained.

3 Financial System Inquiry 2014, Interim Report, July,

page 3-39. 4 Ibid, page 2-10.


The opposite is true for non-standard loans,

where risk weights relative to standard loans are

increased by 25 to 50 per cent.

The effect of this tiering of risk weights is that

under a minimum Common Equity Tier 1 (CET1)

capital ratio of 7 per cent, ADIs with low-risk

housing portfolios, i.e. all loans receiving a 35 per

cent risk weight, could operate with leverage of

around 40:1. In this case they could fund their

portfolio with $40 of deposits and other debt for

each $1 of equity. At the other end of the

spectrum, a loan portfolio of 100 per cent risk-

weighted mortgages would be limited to leverage

of around 14:1. It is not, therefore, correct to

conclude that the standardised approach to credit

risk is insensitive to risk.

If the Inquiry concludes that it is appropriate for

APRA to consider a narrowing of the differential in

risk weights for residential mortgage exposures

between the standardised and IRB approaches to

credit risk, the only proposed option in the Interim

Report that would ensure continued compliance

with the internationally agreed Basel framework

would be to increase the average risk weight used

by banks operating under the IRB approach.

As detailed in APRA’s initial submission,

the Basel Committee is currently reviewing

the validity and reliability of risk weights

generated under the IRB approach in response to

studies showing that the variability in such

measurements is much greater than could be

explained by differences in underlying risks.

The studies have, in particular, focused on low-

default portfolios, where loss history is scarce and

reliable risk estimation and modelling is therefore

problematic. Internationally, this work has focused

on sovereign, bank and large corporate exposures.

Many aspects of this work also have relevance to

Australian residential mortgage markets, where

given the paucity of data generated by periods of

genuine stress, default and loss estimates

inherently require judgement.

A plan for dealing with this variability will be

submitted by the Basel Committee to the G20 for

endorsement later this year. In all likelihood, this

will involve some degree of limitation on bank

modelling practices, as well as potentially

including some floors or benchmarks against which

IRB risk weights will need to be assessed. As a

Committee member, APRA is actively participating

in this review.

In addition, the leverage ratio contained in the

Basel III reforms will, as currently calibrated,

effectively place a floor on the average risk weight

across a bank’s entire loan book.5 Depending on

the final calibration, this effective floor is likely to

be in the order of 35-50 per cent. Analysis by APRA

indicates that the leverage ratio will have a more

significant impact on ADIs using the IRB approach

than those using the standardised approach.

Increasing IRB risk weights could be accomplished

in various ways, including further increases to

APRA’s minimum LGD requirement for residential

mortgage exposures, or preferably through revised

technical assumptions within the IRB framework.

This issue should be considered in the context of

the broader work being undertaken by the Basel

Committee, as the impact of changes to risk

weights needs to be carefully analysed. Greater

prescription in IRB estimates may reduce

incentives ADIs currently have to invest the

resources and management attention required to

model these estimates accurately. It may also

make risk weights potentially less risk sensitive,

and may change relative capital requirements

across asset classes. Any considerations on this

issue also need to be viewed within the context of

the Inquiry’s deliberations regarding the

positioning of Australia’s prudential framework

relative to the global median.

5 The final calibration of the leverage ratio remains to be

agreed by the Basel Committee. The leverage ratio is not scheduled to become a binding requirement on ADIs before 2018, although disclosure requirements are scheduled to commence in 2015.


Funding costs (page 2-16)

The Inquiry would value views on the costs, benefits and trade-offs of the following policy

options or other alternatives:


Provide direct Government support to the RMBS market.

Allow RMBS to be treated as a high-quality liquid asset for the purpose of the liquidity

coverage ratio.

Securitisation offers a number of advantages to

ADIs. Through securitisation an ADI may borrow at

rates determined by the quality of the expected

cash flows from the securitised assets, rather than

its own credit rating. This enables ADIs,

particularly smaller ADIs that have lower

comparative ratings or limited access to wholesale

funding markets, to raise funds at more

competitive rates from a wider range of sources.

Another advantage is that ADIs may be able to

reduce the amount of regulatory capital APRA

requires them to hold against the risks they take

by removing securitised assets from their balance

sheet for capital adequacy purposes. In general,

smaller ADIs use securitisation for both funding

and regulatory capital relief whereas larger ADIs,

which may have more diverse funding sources,

often undertake some securitisations for funding

purposes only.

During the global financial crisis, public sector

intervention was required to underpin demand in

the Australian securitisation market. The

Australian Office of Financial Management’s

(AOFM) purchase of AAA-rated tranches of

Australian issuers’ residential mortgage-backed

securities (RMBS), including non-ADI issuers,

supported competition in Australia’s residential

mortgage market and provided liquidity to some

ADIs that were constrained in their ability to raise

funding. The AOFM’s intervention was designed as

a temporary measure to encourage a transition

towards a more sustainable securitisation market

not reliant on public sector support. By 2013, this

support had been phased out and issuance of

Australian dollar-denominated RMBS was at the

highest level since 2007, as private sector demand

increased.6 Issuance has increased not only for the

largest banks but also for other ADIs and mortgage

originators, with a number of smaller issuers

returning to the market after an absence of

several years.

Options included in the Interim Report relating to

direct government support of the RMBS market

effectively transfer the credit risk associated with

the underlying securitised exposures to the public

sector. Unlike the intervention during the global

financial crisis, the options in the Report extend

beyond the support of highly rated tranches of

RMBS to lower-rated tranches and to the outright

purchase of residential mortgage exposures from

originating ADIs. The consideration of the

appropriateness of these options is an issue for

Government, but the general provision of

additional funding for housing purposes does not

seem necessary given the current level of housing

finance availability. A more nuanced approach

might be to consider the merits of pre-positioning

appropriately priced backstop arrangements,

which would only be activated in the event of

severe financial market disruption. This may help

alleviate the risk of a sharp contraction in credit

provision during a period of financial stress, while

at the same time avoiding support for credit

expansion when it is not demonstrably needed.

6 Debelle, G. 2014, ‘The Australian Bond Market’, speech

to the Economic Society of Australia, Canberra, April.


APRA recently released a discussion paper

regarding the potential for simplification of

the prudential approach for securitisation in

the capital adequacy framework.7 The proposed

approach to securitisation includes the

following features:

a set of key principles that apply to

securitisation, rather than an expanded set of

prudential requirements;

a simple two credit class structure,

which reduces the likelihood of opaque

risk transfer and enhances benefits for

system stability;

a simple ‘skin-in-the-game’ requirement to

mitigate agency risks;

explicit recognition of funding-only

securitisation, with a simple but robust

prudential regime that also allows for

revolving securitisations or master trusts;

simpler requirements for capital relief,

matching risk to the amount of regulatory

capital held;

better integration of securitisation with the

ADI liquidity regime; and

clarification of the treatment of warehouses

and similar structures.

Given the securitisation market in Australia has

been an important contributor to competition,

efficiency and contestability in the ADI industry,

the reforms to the capital adequacy framework

are intended to assist in the further development

of the securitisation market by instituting a

prudential framework that is clear and simple for

stakeholders to understand.

7 APRA 2014, Simplifying the prudential approach to

securitisation, April.

As detailed in APRA’s May 2013 Discussion

Paper Implementing Basel III liquidity reforms in

Australia, the use of RMBS as liquid assets within

the liquidity framework is subject to a number of

qualifying criteria. High-quality liquid assets must

trade in large, deep and active repo or cash

markets characterised by a low level of

concentration, and must have a proven record as a

reliable source of liquidity even during stressed

market conditions. Subject to APRA’s discretion,

RMBS rated AA or higher and not issued by the ADI

itself or any of its affiliated entities can be

recognised for this purpose, within certain

quantitative constraints.

Consistent with the review of the eligibility of

marketable instruments for the purpose of the

Liquidity Coverage Ratio (LCR), RMBS were

considered by APRA against the qualifying criteria.

This review took into account the amount of these

instruments on issue, the degree to which the

instruments were broadly or narrowly held, and

the degree to which the instruments were traded

in large, deep and active markets. Particular

attention was given to the liquidity of these

instruments during the market disruptions of 2007–

2009 in the more acute phases of the global

financial crisis, when the market for RMBS

effectively closed at the same time that ADIs’

need for liquidity was most acute.

Based on this review, APRA concluded in 2013 that

RMBS in Australia were not eligible as liquid assets

for the purpose of the LCR. To rely on instruments

that were not reliably liquid in times of stress

would undermine the intent of the LCR, and give a

false sense of comfort that ADIs could survive a

period of stress without the need for public

sector support.


The market for RMBS has not materially

changed since 2013. The recognition of such

securities as liquid assets for the purpose of the

LCR would be a concessionary treatment and,

therefore, a deviation from the Basel framework

and inconsistent with the Inquiry’s view that

it is appropriate for Australia to maintain

its compliance with that framework. If the

Government chose to provide direct support to

the RMBS market, this could provide greater

potential for a liquid RMBS market to develop

and, importantly, be maintained even in times of

stress. Even so, full recognition of RMBS as liquid

assets would be dependent not simply on the

capacity of ADIs to issue new RMBS (which most

support mechanisms are designed to aid),

but critically on the ability of holders of those

securities to liquidate their holdings quickly,

and without material loss, when needed.

Despite the above, it is not the case that holdings

of RMBS do not receive any recognition within

APRA’s LCR framework: RMBS, including those

issued by smaller ADIs, that are repo-eligible with

the RBA for normal market operations are also

eligible collateral for the Committed Liquidity

Facility (CLF) with the RBA.8 Therefore, ADIs

subject to the LCR regime that use the CLF to

meet part of their requirement for liquid assets

can support this using eligible RMBS.

8 Reserve Bank of Australia 2011, Media Release: The RBA

Committed Liquidity Facility, 2011-25, 16 November.


Lenders mortgage insurance (page 2-23)




Decrease the risk weights for insured loans.

The regulatory capital framework for ADIs has long

reflected the risk-mitigating properties of lenders

mortgage insurance (LMI) in determining the

amount of capital necessary to support insured

residential mortgage exposures. The distinction

between insured and uninsured loans was first

made by the RBA in its then role of prudential

supervisor in 1994: broadly speaking, high-LVR and

non-standard loans received a 50 per cent capital

concession if covered by LMI.9

Since the introduction of the more risk-sensitive

Basel II framework in 2008, the difference in

regulatory capital requirements for insured and

uninsured loans has narrowed somewhat:

under the standardised approach to credit

risk, a more granular set of residential

mortgage risk weights was introduced. For

all standard mortgage loans with an LVR

above 80 per cent, the reduction in risk

weight (and hence capital requirements) is

between one-quarter and one-third. For

non-standard loans, there is a similar sized

reduction across all LVR levels, with the

exception of loans with LVRs above 100 per

cent; and

under the IRB approach, ADIs may also

recognise LMI in their LGD estimates,

although APRA has set a floor of 20 per cent

to the LGD estimate that may be used. This

floor is in response to ADIs’ inability to

satisfy APRA regarding the credibility of

their downturn LGD estimates. One effect

of this floor is to limit the extent of the

capital benefit to ADIs approved to use the

IRB approach that can be recognised for the

use of LMI.

9 Reserve Bank of Australia 1994, Press Release:

Statement by the Governor, Mr Bernie Fraser – Monetary Policy to Tighten, 94-11, 17 August.

APRA also reduced the criteria for eligible

LMI under the capital framework: eligible LMI

need only provide cover for losses of 40 per cent

or more of the original loan amount

(or outstanding balance if subsequently

higher), rather than 100 per cent coverage

as previously required.

Following these changes, LMI continues to be used

as a risk mitigant by ADIs, including the ADIs that

are accredited to use the IRB approach. For these

lending institutions, LMI continues to be seen as

useful in smoothing out the normal variability in

losses that occurs over time. LMI also provides

useful support for ADIs in the event of substantial

idiosyncratic lending losses and helps diversify

regional concentrations of risk. However, given

their stronger credit ratings relative to the

independent LMI providers, it would not be

appropriate for the largest ADIs to seek to rely

entirely on LMI to provide protection against losses

in periods of severe stress. In the event of a major

system-wide housing downturn, the equity

available to the largest ADIs is many multiples

of the financial resources available to the

LMI industry.

With respect to the assumption of a minimum

20 per cent LGD estimate, APRA remains open to

the prospect of ADIs accredited to use the IRB

approach being able to model and demonstrate

the amount of risk reduction that should be

credited to LMI for capital purposes. To date, the

industry has not produced convincing evidence for

relaxing this assumption. Indeed, there have been

suggestions that the current floor is too low.


The above considerations have important

implications for financial system stability and

establishing appropriate ADI capital requirements.

As noted elsewhere in this submission, given the

systemic importance of housing-related risks to the

Australian banking system, the Inquiry should be

wary of proposals that would facilitate further

reductions in capital requirements due to risk

transfer arrangements unless it could be

demonstrated that the risk transfer would be

effective even in times of system-wide stress.

Decreasing the risk weight under the IRB approach

for residential mortgage exposures covered by LMI

also potentially sits at odds with the other policy

options proposed in the Interim Report to reduce

the differential in risk weights between the

standardised and IRB approaches.

Accordingly, APRA does not support any

proposition to further decrease risk weights for

LMI-insured loans.


Insurance sector (page 2-41)

The Inquiry would value views on the costs, benefits and trade-offs of the following alternatives:


Ensure aggregators are able to use automated processes to seek quotes from general insurance websites.

Create comparison categories for insurance products that aggregators could use to compare the value of different products.

The Inquiry seeks further information on the following areas:

Would opening up state- and territory-based statutory insurance schemes to competition improve

value for consumers?

How could insurance aggregators provide meaningful comparisons of policies with different levels

of coverage?

Role of aggregators

Aggregators can serve as a useful ‘one-stop shop’

to provide information to consumers about

products available for purchase. Aggregation

services will generally deliver the best outcome for

consumers where the product being sourced is

largely homogenous and hence where price is a (if

not the) key distinguishing feature. In these

circumstances, consumers can readily compare

and contrast products and pricing to ensure they

find one that best suits their needs.

As noted in the Interim Report, the price of

insurance is important, but value can only be

adequately assessed with an understanding of

the key benefits and conditions of the product

(e.g. coverage, limits on amount of cover,

exclusions, excesses and service levels). If an

aggregator focuses almost exclusively on the

comparison of insurance premiums, consumers

may not be aware of, let alone actively consider,

differences in the terms and conditions of the

policies they are comparing. This issue was

highlighted in a recent review by the United

Kingdom Financial Conduct Authority which found

that some aggregators in that market have not

always taken reasonable steps to provide

consumers with the appropriate policy information

to allow them to make informed choices.10 Not

only does an over-emphasis on price potentially

10 Financial Conduct Authority 2014, Thematic Review

TR14/11 - Price comparison websites in the general insurance sector, July.

lead to ill-informed consumer decisions, it also

encourages competition by insurers purely on the

basis of premium rates rather than the full value

of the services they offer.

The widespread use of aggregators could

conceivably lead to increases in premium rates

because of the impact they can have on insurer

experience. First and foremost, aggregators earn

income from commissions paid by insurers for

business written. This can add to insurers’ costs,

which in turn would likely be reflected in premium

rates. In addition, insurance pricing is not an exact

science and different insurers will typically have

different prices for the same risk. This means that,

at any one time, an insurer will likely be under-

pricing some risks, and over-pricing others. The

use of aggregators can lead to insurers winning a

disproportionate share of business for which they

have inadvertently under-priced. This will

adversely affect their profitability and the

profitability of the industry as a whole. Insurers

may respond by increasing premium rates to allow

them to continue to earn an acceptable return to

shareholders. While this has benefits in the form of

driving more accurate insurance pricing, any

benefit to consumers from initially lower

premiums may be reduced over time.


Where aggregators generate increased frequency

of customer switching, insurers’ costs will increase

because of the associated administration

expenses. Again, insurers can be expected to

increase premium rates to restore profitability.

As to the specific proposals identified in the

Interim Report, APRA notes that:

compelling insurers to provide their products

through aggregator websites is potentially

problematic since there are no barriers to

entry for aggregators and insurers need to be

satisfied with the associated commercial

arrangements for each one;

comparison categories may aid comparison,

but do not solve the underlying problem of

comparing differences in terms and conditions

that can exist even where policies are

targeted, for example, at particular consumer

categories; and

in principle, it would be possible to design

a comparator site that enabled consumers to

compare both price and key policy terms

and conditions. However, there is a balance

between simplicity and complexity, and

meaningful comparisons may not always

be feasible.

State- and territory-based statutory

schemes

Private insurers currently operate in a number of

state-based statutory insurance schemes, including

the compulsory third-party insurance schemes in

New South Wales and Queensland. APRA works

cooperatively with the state-based regulators of

these schemes to ensure the effective

performance of their respective regulatory

functions. There should be no in-principle concerns

with private insurers increasing their participation

in state- and territory-based statutory insurance

schemes, provided they continue to meet APRA’s

prudential requirements. These requirements are

designed to ensure that an insurer’s governance,

risk management and financial strength are

appropriate, and they play an important role in

protecting the interests of policyholders.

The impact on premiums and consumer value from

opening up statutory schemes to private insurers

will depend to a large extent on the existing basis

for pricing. If the state- and territory-based

schemes include organisations that operate on

terms that may be unprofitable, or involve price

controls that limit the ability of insurers to earn an

appropriate return on the capital they need to

invest, the attractiveness to new entrants of

entering these markets will be limited.


Chapter 3 of the Interim Report: Funding

Housing and household leverage (page 2-57)

The Inquiry seeks further information in the following area:

What measures can be taken to mitigate the effects of developments in the housing market on the financial system and the economy? How might these measures be implemented and what practical issues would need to be considered?

APRA concurs with the Interim Report’s conclusion

that since the Wallis Inquiry, the exposure of the

financial system to the housing market has

significantly increased. Residential mortgages now

account for about 60 per cent of the banking

system’s domestic loan portfolio, compared with

around 50 per cent two decades ago and a current

range of 20–40 per cent for most other developed

economies.11 As outlined in APRA’s initial

submission, the level of housing lending reflects a

complex interplay of demand and supply factors,

including the continuation of longer-term trends in

the economy that are largely outside the influence

of prudential regulation.

Given its significance to ADIs’ business,

developments in the housing market have been a

significant area of supervisory focus for APRA over

much of the past decade – well before the lessons

of the global financial crisis became apparent. At

present, this closer supervisory attention has been

driven by a combination of factors, including:

the continued growth in the share of

residential mortgage exposures on the banking

system’s aggregate balance sheet;

higher levels of household leverage, albeit

that this has plateaued in more recent times;

the low interest-rate environment persisting

at present;

house prices that currently are at the

higher end of the recent historical range

relative to income;

strong investor demand (particularly in Sydney

and Melbourne), which could be a sign of

increasing speculative activity;


31 March, Figure A.4, page 89.

competitive pressure on credit standards; and

greater access to credit by marginal

borrowers.

Housing lending has historically demonstrated a

low and stable risk profile compared with other

lending exposures in Australia. Nevertheless, this

has not always been the case overseas and ADIs’

aggregate housing exposures, simply by virtue of

their size, represent a source of systemic risk. The

best means of mitigating the effects of adverse

developments in the housing market on the

financial system is continued vigilance by both

regulated institutions and APRA, including active

monitoring of credit quality and capital

sufficiency, undertaking regular stress-testing

exercises and, most importantly, strong oversight

of ADI risk management and lending standards.


As part of its routine supervisory activities, APRA

undertakes regular onsite prudential reviews of

ADIs’ lending practices. These reviews enable the

identification of emerging issues and trends across

the industry. APRA also analyses data to monitor

the performance of ADIs’ housing portfolios and

regularly surveys ADIs as to any changes in their

credit standards, which allows benchmarking

across the industry and identification of potential

outliers. APRA’s recent communication with the

boards of the largest ADIs also sought assurance

regarding their own oversight of the risk associated

with their housing portfolios.

Earlier this year APRA consulted on new guidance

for ADIs on sound risk management practices for

residential mortgage lending.12 APRA expects to

finalise this guidance shortly.

In addition to this programme of active

supervision, the impact of risks on APRA-regulated

industries is periodically assessed through stress-

testing exercises. Stress testing is an integrated

part of prudential supervision and the stress test

results provide additional insights into areas of

potential vulnerability. Industry stress tests, in

combination with supervisory reviews of

institutions’ own stress-testing programmes,

provide a basis to assess higher-risk lending,

sources of potential loss, and capital resilience.

This is an important part of APRA’s supervision of

risks in the housing market.

12 APRA 2014, Draft Prudential Practice Guide 223

Residential Mortgage Lending, May.

APRA’s 2014 stress-testing exercise covers

13 large ADIs, which together account for around

90 per cent of total industry assets. The stress test

focuses on potential risks in the housing sector,

with scenarios involving sharp increases in

unemployment, significant falls in house prices and

changes in interest rates. Australia has not, in

recent history, experienced a severe housing

market downturn. Scenarios based on historical

experience therefore tend to produce fairly benign

outcomes and APRA’s scenarios are therefore also

benchmarked against overseas experience. These

scenarios are generally more severe than those

considered to date by Australian institutions in

their own stress-testing programmes.

With respect to regulatory settings, it is

sometimes asserted that the relative prudential

capital requirements have influenced the

allocation of ADI lending to housing. Capital

requirements are designed to reflect the risk of

particular exposures, and on that basis should be

broadly neutral with respect to the relative cost to

the business. Nevertheless, as discussed

previously, the Basel II reforms in 2008 did lead

to a substantial reduction in the capital

requirement for residential mortgage exposures

relative to prior levels. It is likely that the benign

housing experience in Australia over a very long

period, coupled with profitable margins, has been

a much greater factor in the expansion in ADI

lending in this area. In addition, for both the

standardised and IRB approaches to credit risk for

housing lending, APRA implemented more

stringent capital requirements relative to the Basel

requirements. This has proved prescient given

recent similar moves among other Basel

Committee member countries.


Impact investing and social impact bonds (page 2-75)

The Inquiry would value views on the costs, benefits and trade-offs of the following policy options or other alternatives:


Provide guidance to superannuation and philanthropic trustees on impact investment.

The requirements and guidance regarding

investment strategy and investment governance

that are currently provided in the Superannuation

Industry (Supervision) Act 1993 (SIS Act), as well as

APRA’s prudential standards and prudential

practice guides, are relevant to all investment

decisions by superannuation trustees. The SIS Act

does not prohibit or preclude impact investment as

long as the requirement to act in the best interests

of beneficiaries is met. Prudential Standard SPS

530 Investment Governance (SPS 530) sets out

APRA’s requirements regarding an investment

governance framework for Registrable

Superannuation Entity (RSE) licensees. This

framework must include the investment strategies

for the whole of each RSE, and for each

investment option, as required by the SIS Act.

SPS 530 does not prohibit impact investment

where appropriate risk and return considerations

are met. Indeed, the standard does not make

any distinction between different types

of investments.

The requirements and guidance regarding

investment strategy and investment governance in

the SIS Act and SPS 530 are relevant to all

investment decisions by superannuation trustees,

including decisions on impact investment. Trustees

must consider such investments on their merits

and in the context of their overall investment

strategy, and are expected to have a sound

understanding of the risk and return

characteristics of all of the investments used to

implement the strategy. APRA would be opposed

to weakening the existing requirement that

trustees act in the best interests of beneficiaries

as a means of encouraging more social impact

investment. Working within the existing statutory

framework APRA would, however, be open to

considering the need for additional guidance

regarding social impact investment, to the extent

that a lack of clarity regarding APRA’s

expectations was seen to be an unnecessary

barrier to additional social impact investment

by trustees.


The banking system (page 2-81)


What effect is the implementation of the Basel III capital and liquidity regimes in Australia expected

to have on the cost of funds, loan pricing and the ability of banks to finance new (long-term) loans?

How large are these effects expected to be?

What share of funding for ADIs is expected to come from larger superannuation funds over the next

two decades? What effect might this have on bank funding composition and costs? What effect will

this have on the ability of ADIs to write long-term loans?

Any analysis of the impact of regulatory changes

on ADIs’ cost of funds and loan pricing needs to

take account of the changed operating

environment faced by Australian ADIs before and

after the global financial crisis. Prior to 2007,

wholesale funding was relatively inexpensive, as

risk premiums were low. As a result, a number of

ADIs became more dependent on offshore

wholesale funding to augment traditional retail

deposit bases, and some ADIs made extensive use

of securitisation markets to fund their residential

mortgage lending. The ready availability of cheap

wholesale funding from offshore also meant that

there was less need to compete for domestic

sources of retail funding to meet lending growth.

The global souring of confidence in banks and

structured credit arrangements from late 2007

onward resulted in large increases in wholesale

funding costs, particularly for longer maturities,

and reduced access to longer-term funding

sources, other than for the most highly rated

banks. During the crisis, securitisation markets

virtually ceased to function. Since 2008, the spike

in funding costs has significantly abated, but retail

deposit funding has subsequently also become

more expensive, as ADIs have more aggressively

competed for this source of funding in the face of

higher wholesale borrowing costs.

These shifts make it difficult to isolate the direct

impact of regulatory reform. Changes to ADIs’ cost

of funds and loan pricing reflect the complex

interaction of a range of factors: regulatory reform

is but one. Internationally, the analysis of the

programme of post-crisis reforms has followed a

cost and benefit model.13

The cost impact in the chain of economic

effects of, for example, higher regulatory capital

ratios involves:

higher equity ratios for banks;

higher weighted funding costs (including

debt and equity funding) and lower return

on equity;

banking institutions increasing lending rates to

restore some of their lost return on equity;

borrowers increasing their aggregate

borrowings more slowly than would otherwise

have been the case; and

gross domestic product (GDP) growing more

slowly than would otherwise have been the

case, for most of the business cycle.

13 Basel Committee on Banking Supervision 2010, An

assessment of the long-term economic impact of stronger capital and liquidity requirements, August.


The benefit chain involves:

higher equity ratios for banks;

safer banks, which can therefore borrow funds

and raise capital more cheaply;

reduced failure of banks and impairment

rates; and

reduced risk and potential depth of

financial crises.

Various international studies have concluded that

the costs of reforms are outweighed by the

benefits. In calibrating the Basel III requirements,

the Basel Committee was guided by, among other

things, the work of its Long-term Economic Impact

working group, which found that:

‘While empirical estimates of the costs and

benefits are subject to uncertainty, the

analysis suggests that in terms of the impact

on output there is considerable room to

tighten capital and liquidity requirements

while still yielding positive net benefits.’14

Subsequent analyses have supported that

conclusion. For example, the International

Monetary Fund (IMF) concluded that:

‘[A]ssessments of the economic costs and

benefits, both transitional and long term, of

the Basel III capital and liquidity standards

have shown that the long-term benefits vastly

exceed the transitional costs.’15

Similar conclusions have been reached in studies

by the Bank for International Settlements and the

Organisation for Economic Cooperation and

Development (OECD).16

14 Ibid, page 1. 15 International Monetary Fund 2012, Global Financial

Stability Report: Restoring Confidence and Progressing on Reforms, October, page 83.

16 Bank for International Settlements 2010, Assessing the macroeconomic impact of the transition to stronger capital and liquidity requirements. Final report, December, and Slovik P. and Cournède B. 2011, Macroeconomic Impact of Basel III, OECD Economics Department Working Papers, No. 844.

APRA agrees with the conclusions of the

international studies that the immediate costs of

the Basel III reforms are relatively minor and

outweighed by the benefits of maintaining an

appropriately conservative level of banking

regulation in Australia. The Basel III reforms were

developed in response to deficiencies in the

capital framework identified during the global

financial crisis, which saw the collapse of banking

institutions around the world and significant long-

lasting impairment of many national economies.

Leaving aside any reform of prudential

requirements, the Australian banking industry and

its funding providers quickly understood that sound

ADIs need much more resilient balance sheets than

prevailed before the crisis. In response to market

expectations, the industry strengthened its capital

and liquidity position well in advance of APRA’s

new prudential requirements. As other countries

have implemented higher minimum capital

requirements, including for systemically important

banks, these expectations have only increased

over time. Some of this strengthening may have

occurred in anticipation of prudential reforms, but

APRA’s view is that Australian ADIs, in common

with widespread global practice, had already

revealed their preference for substantially

stronger balance sheets. As a result, Australian

ADIs have been well placed to meet the higher

Basel III requirements.


APRA has set out a quantification of potential

impacts in its Basel III capital and liquidity

Regulation Impact Statements (RISs).17 The

estimated loan rate increase following

implementation of the Basel III capital rules for an

average non-housing loan by a large Australian

bank was estimated to be of the order of 0.10 per

cent per annum. The increase for a home loan was

estimated at around 0.04 per cent per annum.18

These outcomes will vary depending on the size of

the ADI, its capacity to pass through the cost of

higher equity funding, the extent to which the

increased security of the ADI reduces the return on

equity demanded by shareholders, the relative

riskiness of the loan and a range of other factors.

Irrespective of the assumptions made, the key

point is that the loan pricing effects of the new

minimum capital requirements are very small

relative to other factors. The impact of changes in

the risk-free rate and the spread of funding costs

over the risk-free rate, for example, would be far

more significant than any reasonable estimate of

the loan pricing effects associated with enhanced

minimum capital requirements.

APRA’s RISs also addressed the estimated impact

of the implementation of the LCR, which will come

into force on 1 January 2015 and will only apply to

larger ADIs.19 As detailed in the RIS, the average

loan rate increase following implementation of the

Basel III liquidity rules is estimated at 0.03 per

cent per annum, which is again a relatively small

increase relative to overall changes in funding

costs that can occur from year to year.

17 The RIS process is described in APRA 2014, Financial

System Inquiry Submission, 31 March. 18 APRA 2012, Regulation Impact Statement: Implementing

Basel III capital reforms in Australia, page 15. 19 APRA 2013, Regulation Impact Statement: Implementing

Basel III liquidity reforms in Australia.

In addition to the LCR, the Net Stable Funding

Ratio (NSFR) will also apply to some ADIs from

1 January 2018. The NSFR will likely prescribe a

minimum amount of longer-term and stable

funding that must be sourced by ADIs as a result of

the volume of longer-term assets on their balance

sheet. This requirement is designed to limit over-

reliance on short-term wholesale funding and

encourage a better assessment of liquidity risk.

The NSFR requirement has not yet been finalised

by the Basel Committee, which makes it difficult

for APRA to quantify the impact of its

implementation at this stage. It is unlikely,

however, that the final implementation of the

NSFR will force ADIs to materially increase the

average tenor of their funding beyond that which

has already occurred in response to vulnerabilities

that became apparent during the financial crisis.

It is difficult to assess the extent of

superannuation investments flowing,

directly and indirectly, into the banking

system. Over the past decade, the share of large

superannuation funds’ assets directly invested in

cash and deposits with ADIs has

risen from under three per cent in 2004 to almost

eight per cent in 2013.20 Most of this increase

occurred after the onset of the global financial

crisis, as trustees (often as a result of member

investment choice) sought lower risk exposures in

capital guaranteed products in the face of

significant market volatility. This also reflected an

increased awareness of liquidity risk, and the

subsequent premium placed by large

superannuation funds on assets that are at-call,

including during times of stress. There will be an

ongoing need for superannuation funds to maintain

some level of liquid assets, but it is not yet clear

the extent to which levels held may change as

liquidity management practices of trustees are

enhanced over time following the implementation

of APRA’s prudential standards.

20 Data from the 2013 edition and previous editions of the

APRA Annual Superannuation Bulletin. It excludes indirect investments through, for example, managed investment schemes and life policies.


When short-term deposits are placed by

superannuation funds with larger ADIs, it is not

expected that LCR requirements will impede the

ability of ADIs to on-lend those funds to other

borrowers due to the availability and operational

requirements of the RBA’s CLF.21 Where

superannuation funds invest in longer-dated

banking liabilities, the LCR will impose minimal

constraint on the ADI, as the LCR only captures

such investments when they are within one month

of maturity.

Although not yet finalised, the NSFR requirement

is also expected to encourage ADIs to seek longer-

term funding, including from superannuation funds

which may be well placed to provide this type of

funding. Greater focus on retirement incomes

(as discussed elsewhere in this submission) may

well generate greater demand for longer-term

fixed interest investments generally, which ADIs

are well placed to offer. Over time, these factors

may encourage a greater share of stable ADI

funding to be sourced from the superannuation

sector, thereby supporting ADIs’ ability to provide

longer-term finance to customers.

21 Reserve Bank of Australia 2011, Media Release: The RBA

Committed Liquidity Facility, 2011-25, 16 November.


The corporate bond market (page 2-91)


Allow listed issuers (already subject to continuous disclosure requirements) to issue ‘vanilla’ bonds directly to retail investors without the need for a prospectus.

If listed issuers were permitted to issue ‘vanilla’

bonds directly to retail investors without the need

for a prospectus, care would be needed to ensure

that investors were not under the impression that

such products offer the same level of security as

deposits in an ADI. Australia currently has a

differential regime for registered financial

corporations (RFCs), which may raise non-deposit

funds from retail investors through the issue of

debentures. However, shortcomings in this regime

have become evident, with some investors lacking

an understanding of the important differences

between these products and ADI deposits, despite

the requirement for RFCs to issue Product

Disclosure Statements. As a result, APRA is

currently proposing to tighten this regime in such a

manner as to ensure there should be no confusion

between RFC-issued debentures and transactional

accounts traditionally held with ADIs.

The need for clarity about the nature of a bond-

type product would be amplified if the vanilla

bond issuer was itself an ADI. Here, the distinction

between term deposits (which are subject to

depositor preference under the Banking Act 1959

(Banking Act) and may also be covered by the

Financial Claims Scheme (FCS)) and non-deposit

bonds would need to be carefully delineated.

It will also be important to ensure that

subordinated debt and ‘hybrid’ securities issued by

APRA-regulated institutions continue to require a

prospectus. These products have increasingly

complex features, and as a result of recent

regulatory reforms are designed to ensure they

bear loss in the event the issuing institution

encounters difficulty. They are therefore much

more akin to equity instruments than debt

instruments in their risk profile. Given the

discussions in Chapter 5 of the Interim Report

regarding the possibility of introducing additional

means of imposing losses on creditors, and the

complexity such arrangements would necessarily

entail, the ability for unsophisticated investors to

hold these instruments is of increasing relevance.

To this end, the United Kingdom Financial Conduct

Authority recently announced restrictions in

relation to the British retail distribution of

contingent convertible instruments.22

22 Financial Conduct Authority 2014, Temporary product

intervention rules. Restrictions in relation to the retail distribution of contingent convertible instruments, August.


Chapter 4 of the Interim Report: Superannuation

Efficiency (page 2-114)


No change to current arrangements and review the effectiveness of the MySuper regime in due course.

Consider additional mechanisms to MySuper to achieve better results for members, including auctions for default fund status.

Replace the three-day portability rule:

- With a longer maximum time period or a staged transfer of members’ balances between funds, including expanding the regulator’s power to extend the maximum time period to the entire industry in times of stress.

- By moving from the current prescription-based approach for portability of superannuation benefits to a principles-based approach.

APRA agrees with the Inquiry’s view that fees

should not be considered in isolation; assessment

of the efficiency of the superannuation sector

must be framed in terms of the ultimate outcomes

that are achieved for members.23 For any given

pattern of contributions, members’ outcomes are

driven primarily by investment performance,

taking into account risk and return objectives as

well as investment time horizons. Insurance and

other benefit design aspects, fees, costs, taxes

and the form and timing of benefits taken by

members are also relevant considerations.

There are also a number of different types of fees

and costs that need to be considered separately

when assessing efficiency, including fees and costs

for investment management, administration,

insurance and advice. It is important to take

into account all of these different factors when

making comparisons with other jurisdictions;

this makes like-for-like international comparisons

particularly complex.


page 2-101.

Superannuation funds should be assessed based on

a range of factors, including after-fee and after-

tax returns for the selected risk profile. The risk

and expected after-fee and after-tax return profile

of a superannuation product will be influenced by

a range of considerations, some of which will

influence the selected investment strategy.

These considerations include: the benefit

structure; membership profile including age

characteristics and occupational profile; overall

expectations for fund size, stability and growth

rate of assets under management; the broader

state of financial markets; and the decisions

taken by trustees to reflect the best interest

of members.

A range of different investment strategies, and

also overall cost and fee structures, may be

expected to deliver appropriate member outcomes

over the long term. It is not necessarily the case

that the lowest fee structure will provide better

outcomes for members over the long term.

Similarly, a focus on other ways in which to

enhance overall long-term member outcomes,

such as more tax-effective investment

management, may have a more material impact

than achieving relatively small reductions in

investment or administration fees for members.


From a prudential perspective, ultimate member

outcomes are enhanced by a robust and well-

managed superannuation sector. This requires

adequate investment in, and maintenance of,

infrastructure and controls consistent with

meeting APRA’s requirements for sound risk

management. In determining the appropriate level

of costs incurred and fees to be charged to

members, trustees must therefore strike an

appropriate balance between the amount required

to maintain adequate systems, processes and

controls over time with a desire to ensure that the

fees charged to members do not unduly reduce

ultimate member outcomes.

Effectiveness of the MySuper regime

Trustees that have met the authorisation

requirements have been able to offer MySuper

products since 1 July 2013. MySuper products must

meet certain criteria that are, in part, intended to

enable the public to more easily compare key

attributes, including fees. Although the MySuper

regime is still in its infancy, there are signs that its

introduction has encouraged an increased focus by

trustees on the features of the superannuation

products they offer, the related operating costs,

and hence the level of fees charged to members.

This, in turn, has led to some evidence that such

costs and fees are beginning to fall.24 As the

Inquiry notes, however, it is too early to assess

whether the MySuper reforms will achieve their

objectives, in particular in reducing industry costs

and fees.25

24 Rice Warner 2014, FSC Superannuation Fees

Report 2013, commissioned by the Financial Services Council, May.

25 Financial System Inquiry 2014, Interim Report, July, page 2-106.

APRA has collected data on authorised MySuper

products since they became available. Publication

of detailed product-level data, including fees

charged, costs incurred and net return

information, will significantly improve

transparency in relation to MySuper products, in

line with the objectives of the MySuper reforms. It

is also expected to enhance competition. APRA has

published summary information about MySuper

products and is proposing to commence more

detailed product-level publications in the near

future. By publishing more detailed information

APRA expects to intensify the focus by trustees

and other industry stakeholders on the efficiency

of operations such as investments, administration

and insurance, and associated cost and fee

structures, across the sector. However, it is

important that there is continued focus on the

achievement of adequate overall outcomes for

members over the long term.

It should be noted that, from the information

available to APRA, there is variation in industry

practices regarding cost and fee reporting and

disclosures. APRA is working to refine the relevant

prudential reporting returns and instructions to

support a more consistent approach across the

industry. This has been done in concert with the

Australian Securities and Investments Commission

(ASIC), which has been reviewing industry

disclosure practices, and should enhance the

quality of the published information over time.


A review to assess the effectiveness of the

MySuper regime in achieving its objectives,

including its impact on the level of fees and costs

by type and in total, would most appropriately be

undertaken in, say, three years’ time. This will

allow a sufficient period for the reforms to be fully

implemented. A review in three years would align,

for example, with the end of the transition period

for trustees to transfer balances of members in

existing default funds into a MySuper product on

1 July 2017. The SuperStream reforms, which are

expected to reduce costs and hence fees over

time, will also have been in operation for a

few years.

Auctions for default fund status

In outlining options for reducing fees and

increasing after-fee returns, the Interim Report

identifies as worthy of consideration the approach

taken in Chile, where the government mandates

that the superannuation contributions of new

members be placed in the same default fund. For

the purposes of the mandatory default

arrangement, fund investment management is

auctioned on the basis of fees. The Report notes

that since the introduction of this arrangement,

the fees charged by successful bidders in Chile

have fallen by 65 per cent, although fees for other

funds have not fallen to the same degree.26

While this reduction is significant, a focus on

fees alone may compromise overall outcomes for

members given, for example, the likelihood that in

seeking lower costs there may be a trend to use

investment approaches and asset classes with

lower transaction costs and potentially lower

returns. As with the MySuper regime in

Australia, the Chilean system has only been in

place for a short time and, notwithstanding the

observed impact on fees charged, it is likely too

early to assess its success in terms of overall

member outcomes.

26 Ibid, page 2-112.

In addition, the superannuation framework in Chile

is characterised by detailed controls, the nature of

which are inconsistent with the more principles-

based approach adopted in Australia. The

Australian market is also structurally different

from that of Chile in that in Australia there are a

larger number of superannuation funds and hence

there is greater scope for competition.

For these reasons, care needs to be taken in

placing too much focus on comparisons with the

Chilean approach.

The three-day portability rule

The three-day portability rule for outbound

rollovers replaced a previous obligation on trustees

to roll over funds within 30 days. The industry had

in practice, however, been operating within a

5-10 day timeframe for processing the majority

of rollovers.

The introduction of the three-day portability rule

has created operational difficulties for elements of

the superannuation industry, particularly in

circumstances where, for example, a

superannuation fund undertakes weekly forward

unit pricing or has peak administration processing

periods. This has resulted in a number of relatively

immaterial breaches where trustees have found

themselves in a position of technical non-

compliance in circumstances that do not otherwise

raise prudential concerns.

APRA supports a change to a slightly longer period,

such as five to seven days. This would achieve the

objective of ensuring most rollovers are processed

quickly and address the operational difficulties

superannuation funds are experiencing in meeting

the current requirement.


While APRA generally favours adopting a

principles-based approach across the prudential

framework, there are strong arguments in favour

of a prescriptive approach within the payment

standards, given the transactional nature of the

activities under consideration and the need for

clarity and certainty for participants. As the

Inquiry has noted, without an objective benchmark

with which to judge the amount of time to

complete a transfer to another superannuation

fund, a principles-based approach may create

more ambiguity for all parties involved.27

As noted in the Interim Report, under the

provisions of the Superannuation Industry

(Supervision) Regulations 1994, in specific

circumstances a trustee may apply to APRA for

relief from the portability requirements in respect

of part or the whole of a fund for a limited period

of time.28 APRA provided relief to a number of

funds’ choice options which had invested in assets

which became illiquid during the global financial

crisis. This process was effective and provided

sufficient flexibility for APRA and the affected

funds to address the issues being faced at that

time. Further, the powers to provide relief can be

applied to the whole of the industry if necessary.

There does not appear to be a need for any

changes to, or extension of, APRA’s current powers

in this area.

27 Ibid, page 2-114. 28 r.6.37 of the Superannuation Industry (Supervision)

Regulations 1994.

The superannuation industry has increased its

focus on liquidity risk management practices since

the global financial crisis. Monitoring processes

have improved and superannuation funds are

developing frameworks to facilitate liquidity

stress testing. However, there are perceptions

that a perhaps unduly high level of liquidity is

needed to manage stress situations, to facilitate

member switching, and as a counterbalance to

greater investment in illiquid investments such

as infrastructure.

APRA notes that the change to the portability rules

does not appear to have materially affected the

investment strategies of superannuation funds by

altering trustees’ decision-making in relation to

holding liquid and illiquid assets. Indeed, member

choice may have had a bigger impact in this

regard. As superannuation funds become more

familiar with the prudential requirements and

guidance and develop more nuanced approaches

to liquidity management, APRA expects any

misperceptions in relation to the required level of

liquidity to be less likely.



Does, or will, MySuper provide sufficient competitive pressures to ensure future economies of scale will be reflected in higher after-fee returns? What are the costs and benefits of auctioning the management rights to default funds principally on the basis of fees for a given asset mix? Are there alternative options?

Is there an undue focus on short-term returns by superannuation funds? If this is a significant issue, how might it be addressed?

Competitive pressure in the MySuper

regime

Although the MySuper regime is still in its infancy,

its introduction does appear to have encouraged

an increased focus by trustees on the features of

the superannuation products they offer, the

related costs incurred, and hence the level of fees

charged to members. This, in turn, has led to some

evidence that such costs and fees are beginning to

fall.29 The publication of detailed MySuper

product-level data by APRA, including fees

charged, costs incurred and net return

information, will significantly improve

transparency and competition in this sector,

further supporting the objectives of the MySuper

reforms. However, APRA agrees with the Inquiry’s

view that it is too early to assess whether the

MySuper reforms will achieve their objectives,

including in reducing industry costs and fees.30

The product dashboard requirements for both

MySuper and ‘choice’ products are also intended

to provide engaged members, their advisers and

other industry stakeholders with key forward- and

backward-looking information about these

products. In the case of disengaged members, this

information is primarily aimed at advocates

including employers, promoters and product rating

houses. The dashboard information for a product

includes the return target, the level of investment

risk, the returns for previous financial years, a

comparison between the return target and the

returns for previous financial years and a

statement of fees and other costs.

29 Rice Warner 2014, FSC Superannuation Fees

Report 2013, commissioned by the Financial Services Council, May.

30 Financial System Inquiry 2014, Interim Report, July, page 2-106.

As noted above, a focus on fees alone may

compromise overall outcomes for members given,

for example, the likelihood that in seeking lower

costs there may be a trend to use investment

approaches and asset classes with lower

transaction costs and potentially lower returns.

The auctioning of investment management rights

to default funds principally on the basis of fees for

a given asset mix may therefore adversely affect

member outcomes.

Focus on short-term returns

Superannuation is structured to be a long-term

saving vehicle for members during their working

life, in order to provide adequate income during

retirement. Consequently, investment strategies

set by superannuation funds for their members

should reflect this long-term objective.

In practice, however, there has often been a

disconnect between the long-term investment

objective and the shorter-term measures of

investment performance communicated to

members by trustees and market commentators.

Longstanding industry practice has been to report

on and compare short-term investment

performance relative to peers (based on for

example monthly, quarterly and annual returns)

for a product that should be managed and

assessed based on performance relative to

established investment objectives over a much

longer time horizon.


This short-term focus is typical where defined

contribution arrangements are operated as

investment accounts, retirement outcomes are

stated in terms of growth in asset value and

investment decisions focus on returns, with risk

measured as volatility of those returns. While the

extent and actual impact of this short-term focus

is unclear, anecdotally there is some evidence of a

negative impact on investment behaviour.

APRA considers it important to publish information

on the longer-term performance against

established investment objectives for both

MySuper and choice products, consistent with the

basis on which the investment strategies are set.

APRA’s new publications will therefore include an

increased focus on such longer-term performance

measures. It will take some time, however, for

sufficient and reliable long-term performance

information to be available on MySuper products.

In seeking to discourage an overly short-term

perspective on returns in the superannuation

industry, a broader reconsideration of the focus of

retirement savings may be merited. By focusing on

retirement income adequacy and sustainability

rather than wealth accumulation at retirement

date, performance and risk metrics can be more

effectively aligned with members’ goals of

maximising the likelihood of achieving and

maintaining a desired level of income throughout

retirement. This will require the superannuation

industry to significantly change its approach in a

number of areas, including in particular

investment management and communication and

engagement with members.

Leverage (page 2-117)


Restore the general prohibition on direct leverage of superannuation funds on a prospective basis.

APRA has long had reservations about extending

the ability of superannuation funds to borrow and

was reluctant to facilitate relaxation of the

borrowing rules, which took place in 2007, to

accommodate instalment warrants.

A degree of indirect leverage already exists within

many assets commonly held by superannuation

funds, including listed equities, fixed income and

property investments. Additional direct leverage

may amplify returns but exposes superannuation

fund members to greater financial risks.

APRA remains of the view that the risks associated

with direct leverage are incompatible with the

objectives of superannuation and cannot

adequately be managed within the superannuation

prudential framework. Direct leverage can

multiply the returns from investment in rising

markets but it can also multiply losses in falling

markets. Where borrowing is undertaken for

investment in illiquid assets such as property, it

can form a relatively large part of the portfolio,

reducing the opportunity for diversification and

hence further increasing risks.


Chapter 5 of the Interim Report: Stability

Imposing losses on creditors (page 3-12)



Increase the ability to impose losses on creditors of a financial institution in the event of its failure.


Is it possible to reduce the perceptions of an implicit guarantee for systemic financial institutions by imposing losses on particular classes of creditors during a crisis, without causing greater systemic disruption? If so, what types of creditors are most likely to be able to bear losses?

The failure of several overseas banks during the

global financial crisis highlighted the risks and

challenges of trying to deal with distressed banks

through a standard corporate insolvency regime.

The web of connections between financial

institutions and the rapid spread of risk across the

financial system meant that it was difficult for

regulatory authorities to impose losses on bank

creditors while still achieving financial stability

objectives. Furthermore, the lack of adequate

contingency planning and alternative mechanisms

for handling bank failure in many cases

exacerbated an already fragile environment. This

left little option but to resort to government-

backed recapitalisations of several banks. While

undoubtedly stabilising the financial system, these

actions have reinforced perceptions of an implicit

guarantee for systemic banks and reduced the

perceived likelihood of unsecured bank creditors

being exposed to the risk of loss on their

investments. In such circumstances, market

discipline is reduced and moral hazard increased.

No Australian ADI failed during the global financial

crisis. However, the industry did receive

substantial public sector support. The Australian

Government and the agencies of the Council of

Financial Regulators (CFR), recognising the risks

emerging at that time, took a number of steps at a

system-wide level to support financial stability. As

noted in APRA’s initial submission to the Inquiry,

the experience of the crisis has raised broader

questions about how Australia’s regulatory

agencies can ensure the continuity of the critical

functions provided by financial institutions in a

future crisis, while protecting the interests of

depositors and insurance policyholders and

minimising the possibility of losses being borne by

the public sector.

The Australian response to the global financial

crisis has largely mirrored steps taken in other

jurisdictions, and has been guided by the

agreements reached by international standard-

setters. The primary set of reforms has been the

implementation of the Basel III capital regime in

Australia, which is a critical step in increasing the

resilience of Australian ADIs to financial shocks,

and hence reducing the probability of their

failure. With the design of Basel III now largely

complete, international attention, driven by the

G20 and the Financial Stability Board (FSB), is now

shifting towards measures that reduce the impact

of the failure of systemically important banks.


Australia has already taken some steps of its own

in this area, including the establishment of the

FCS and the work of the CFR to improve crisis

management arrangements and resolution

planning. More work needs to be done to

strengthen the resolution framework in Australia,

and APRA welcomes the consideration by the

Inquiry of ways in which the effects of an ADI

failure might be made more manageable and

create fewer risks of disruption to the wider

financial system as well as economic activity

more generally.

The larger ADIs have started to consider their own

recovery actions should they encounter a period of

significant financial stress. This would include

options to raise additional capital, liquidate assets,

generate liquidity and funding, and preserve core

functionality. ADIs need to consider and develop

viable options in cases of both idiosyncratic and

system-wide stress. If substantial actions are

activated promptly when a period of stress occurs,

an ADI will ideally be able to restore and preserve

its financial health without the need for regulatory

intervention. There always remains a risk,

however, that these recovery actions are

insufficient, in timeliness or scale, to deal with the

extent of the problems an ADI may face.

At the point when an ADI’s own recovery actions

have proven inadequate and APRA considers that

the ADI is no longer viable, the ADI is likely to have

incurred, or is about to incur, significant losses. In

addition, there is likely to be substantial

uncertainty about the value of the ADI’s remaining

assets and liabilities, and community nervousness

about the potential for similar problems in other

ADIs. In insolvency, shareholders absorb losses

first, followed by subordinated debt-holders and

then senior unsecured creditors, with the amounts

recovered determined at the end of the insolvency

proceedings.31 But for many financial institutions,

and particularly ADIs, financial stability objectives

typically mean that there is no time to allow

normal commercial insolvency proceedings to run

their course. A major corporate liquidation may

require years to resolve through the courts; the

necessary timeframe for resolving a substantial

ADI failure is more typically measured in days

and hours.

31 Under the Banking Act, Australian depositors are

preferred in the creditor hierarchy.

There are two fundamental sources for this

urgency in dealing with a failing ADI:

a loss of critical functionality

provided by the ADI (e.g. access to

transactional banking accounts and

payment facilities); and

a loss of confidence by depositors and

market participants spreading disruption to

other parts of the financial system.

An inability to have mechanisms to respond quickly

to these two concerns without resorting to the

need for public sector support is at the heart of

the ‘too big to fail’ problem. More precisely, ADIs

may be too big, too interconnected or too

important to allow the authorities to rely upon

standard liquidation tools in the event of a failure,

as to do so would impose unacceptable costs on

the broader community.

The FCS provides one mechanism for depositors to

access their funds in a failed ADI in a timely

manner, thereby reducing the risk of disruption

spreading more broadly, while the ADI is wound

down over time. In this scenario, losses are

absorbed by general creditors through the

liquidation of the remaining assets and liabilities.

If these are insufficient, a levy is applied to other

ADIs to cover any residual losses and to ensure

depositors can receive the full amount of their

covered deposits. Some form of deposit insurance

system has been established in almost all OECD

countries, with widespread recognition that they

provide important financial stability benefits.


Deposit insurance on its own is insufficient to deal

with all circumstances of a failing ADI, however.

Although all ADIs incorporated in Australia are

covered by the FCS, there may be circumstances in

which the CFR authorities consider that resolution

of a failing ADI simply by placing it into liquidation

and utilising an FCS payout would be insufficient to

meet financial stability objectives. For example,

an ADI may perform certain functions which need

to be continued, or at the very least wound down

in an orderly manner outside normal insolvency in

order to avoid potential contagion to the financial

system. APRA considers that other resolution

options are needed for such circumstances. Where

possible, these options should minimise the need

for public sector support.

Any resolution option that avoids reliance on

public sector solvency support must provide for

losses made by the failing ADI to be absorbed by,

first, its capital providers and then its unsecured

creditors. For such an approach to be credible and

feasible there needs to be a level of transparency

and understanding among market participants

about how losses would be allocated. In addition,

the authorities need a set of resolution powers

that are flexible enough to allow them to

implement the plan as efficiently as possible in a

manner that meets financial stability objectives.

A primary objective for global policymakers, under

the direction of the G20 Leaders, is that global

systemically important banks (G-SIBs) should no

longer be seen as too big to fail. One of the most

important elements of this policy goal is the effort

to devise credible and transparent mechanisms

that will allow losses incurred by a failing bank to

be imposed on certain classes of bank creditors.

This should help reduce any perception of an

implicit guarantee for the holders of bank funding

and capital instruments, and thereby promote

market discipline and reduce moral hazard.

Following endorsement of the concept by the G20,

the FSB is currently developing proposals that

would require G-SIBs to issue a minimum amount

of liabilities that could credibly and feasibly absorb

losses in resolution and contribute to the failing

bank’s recapitalisation. Australia is contributing to

this work through its membership of the FSB and

Presidency of the G20, as well as through APRA’s

membership of the Basel Committee. Current

plans are for a proposal on the structure and

minimum amount of loss-absorbing and

recapitalisation capacity to be released for

consultation towards the end of this year.

The Australian authorities will need to be mindful

of the emerging international requirements for G-

SIBs, given:

some jurisdictions will extend the

implementation of the loss-absorbing and

recapitalisation capacity requirements

beyond G-SIBs;

Australian ADIs will be competing against

banks meeting these requirements when

seeking debt funding in wholesale markets,

where the existence or absence of a layer of

liabilities designed to absorb losses and

recapitalise a bank in resolution would

potentially impact relative pricing; and

rating agencies may well adjust their ratings

to take account of the additional loss-

absorbing capacity available to senior

creditors of some banks and not others.

Instruments comprising loss-absorbing and

recapitalisation capacity may take a number of

different forms, each of which has advantages and

disadvantages. For example, the FSB’s proposals

may establish a form of prescribed instruments (as

for existing bank capital), or it could establish a

framework that recognises more generally any

liabilities that have certain characteristics that

would allow them to credibly absorb losses at the

point of failure.


It should also be noted that the existing Basel III

regime already contains a form of ‘gone concern’

capital. Term subordinated debt is eligible to be

included in Tier 2 capital only if it includes a ‘point

of non-viability’ trigger. This trigger provides

additional loss-absorbing capacity through the

write-off of the liability or its conversion into

ordinary shares, if APRA considers the ADI to be no

longer viable. Tier 2 capital therefore already

provides some loss-absorbing and recapitalisation

capacity for Australian ADIs.

Under the current Basel framework, however,

there is no requirement for ADIs to issue a

minimum amount of Tier 2 capital. ADIs are free to

use other, higher quality capital instruments to

meet their total capital requirement and have

tended to do so in recent years. While this

approach serves to reduce the probability of

failure, it provides little additional loss-absorbing

capacity once the ADI has failed. If the Inquiry

considers a minimum loss-absorbing and

recapitalisation capacity requirement would be

appropriate for Australia to improve the resilience

and resolvability of Australian ADIs, a minimum

Tier 2 capital requirement, at least for banks

designated as D-SIBs, might help meet some part

of this requirement. Utilising existing regulatory

requirements and established instruments would

also avoid the need to devise additional new

requirements and instruments and will, in all

likelihood, be consistent with emerging

international standards. However, before

establishing a specific Tier 2 requirement, it would

be important to consider the relative cost, and

availability, of greater issuance of Tier 2

instruments, and the extent to which this would

be sufficiently aligned with other approaches being

developed by the FSB.

The design of the appropriate mechanism through

which losses are imposed on relevant creditors in

resolution is dependent on the form of loss-

absorbing capacity held by Australian ADIs. Tier 2

capital instruments are required to have a

contractual mechanism for conversion or write-off

at the point of non-viability of the institution. On

the other hand, other forms of loss-absorbing

capacity may require the use of a statutory power

by the resolution authority in order to be

genuinely loss-absorbing in resolution.

To this end, some jurisdictions have introduced a

statutory ‘bail-in’ power, which gives resolution

authorities the power to write down, or convert

into equity, unsecured and uninsured creditor

claims to the extent necessary to absorb losses.

The resulting reduction in liabilities is intended to

recapitalise the failed bank in such a way that it

can continue to provide critical economic

functions. Although this approach is attractive

because it provides a means to transfer the risk of

a bank failure away from the public sector to the

bank’s own creditors, it does not come without

costs and risks. At a minimum, the holders of debt

subject to bail-in may seek additional spreads to

cover any perception of increased risk. In a

systemic crisis, bail-in of the creditors of one bank

may lead to a run on other banks as creditors seek

to avoid a similar bail-in.

Australia does not have a statutory bail-in power.

APRA does have compulsory transfer of business

powers, which, in certain circumstances, could be

used to achieve a similar economic effect to a

bail-in.32 Subject to certain triggers and

safeguards, this power could be used to transfer a

failing ADI’s assets to another entity, leaving

behind capital instruments and certain unsecured

liabilities to absorb losses.

32 APRA notes that the FSB does not consider these powers

to be fully equivalent to a statutory bail-in instrument. This is, in part, due to the considerable increase in operational complexity and execution risk in implementing such a transfer.


If increased powers to bail-in creditors were to be

introduced in Australia, consideration would need

to be given to whether there should be limitations

on the holdings of debt subject to bail-in by

certain classes of investors, particularly retail

investors. To be effective in providing an orderly

means of quickly resolving a failed ADI, it is likely

that any requirement for loss-absorbing and

recapitalisation capacity will include disincentives

for ADIs to hold such instruments issued by other

ADIs. This is designed to ensure that the

conversion or write-off of these instruments does

not simply transfer losses elsewhere in the banking

system, causing further instability. To be able to

ensure that debt subject to bail-in could be

credibly and reliably written-down when needed,

it would be important that, as far as possible,

holders understood the risks to which they were

exposed. This may suggest that bail-in debt is best

held by sophisticated wholesale investors, who are

more likely to be able to assess, and appropriately

price, such risks. As detailed in the section on the

corporate bond market in APRA’s response to

Chapter 3 of the Interim Report, the United

Kingdom Financial Conduct Authority recently

announced restrictions in relation to the British

distribution of contingent convertible instruments.

With all of the above as background, APRA does

not advocate any particular framework for, or

form of, loss-absorbing and recapitalisation

capacity at this time, given the nuances of

different approaches are yet to be well

understood. Moreover, there seems little benefit

in Australia moving ahead of international

developments in this area.

Resolution powers (page 3-13)



Strengthen regulators’ resolution powers for financial institutions.

APRA’s current crisis resolution powers, which are

detailed in the Industry Acts, are a vital

component of the prudential framework. Having a

robust set of legal powers is important in ensuring

that APRA can respond effectively to situations of

distress at regulated institutions.

The global financial crisis highlighted the lack of

credible resolution options and the inability of

regulators to resolve failing financial institutions

quickly without resorting to significant public

sector support. The FSB has since urged member

countries to undertake necessary legal reforms to

equip national authorities with the capacity to

respond effectively to an institution under severe

stress. It has emphasised the need for clear and

comprehensive legal powers to enable distress to

be managed in a manner consistent with

minimising financial system instability, avoiding or

minimising taxpayer risk and facilitating effective

cross-border crisis resolution.

To assist in the process of strengthening resolution

regimes, the FSB published the Key Attributes of

Effective Resolution Regimes (Key Attributes) to

provide an international standard on financial

crisis resolution. Although some parts of the Key

Attributes apply only to global systemically

important financial institutions (SIFIs), of which

there are none in Australia, most of the Key

Attributes have been drafted for wider application

to domestic SIFIs and other financial institutions,

including insurers and financial market

infrastructure. Accordingly, the Key Attributes

provide an international benchmark relevant to

much of the Australian framework for resolving

regulated institutions.


APRA’s resolution regime is broadly consistent with

minimum international standards, including the

Key Attributes.33 As noted in the Interim Report,

there are some remaining gaps and deficiencies in

APRA’s resolution regime when compared with the

Key Attributes. In any future crisis, having a wider

range of tools available will mean that it is more

likely that a credible, low-cost option for

preventing a disorderly failure can be found that

responds effectively to the specific circumstances

and without putting taxpayer funds at risk.

APRA therefore concurs strongly with the Inquiry’s

view that current proposed legislative reforms to

its crisis management powers are important and

should be implemented as a matter of priority.

These legislative measures were initially raised in

the September 2012 Consultation Paper,

Strengthening APRA’s Crisis Management Powers,

and include the following measures:

directions powers, including clarifying that

APRA may direct a regulated institution to pre-

position for resolution, and ensuring that

directors are protected from liability when

complying with an APRA direction;

group resolution powers, including extending

APRA’s power to appoint a statutory manager

to an ADI’s authorised non-operating holding

company and subsidiaries in a range of distress

situations, and widening the scope of

application of the Financial Sector (Business

Transfer and Group Restructure) Act 1999 to

related entities;

resolution of branches of foreign banks,

including enabling APRA to apply to the Court

for the winding up of the Australian business

of a foreign ADI, and clarifying that APRA may

direct a compulsory transfer of business to or

from a foreign branch;

33 International Monetary Fund 2012, Australia: Financial

System Stability Assessment, IMF Country Report No. 12/308.

statutory and judicial management powers,

including widening the moratorium provisions

applicable when a statutory or judicial

manager is appointed, and extending more

robust immunities to statutory and judicial

managers; and

investigation powers, including removal of the

‘show cause’ notice in the Insurance Act 1973

(Insurance Act) and Life Insurance Act 1995

(Life Insurance Act), and providing an

appointed investigator with the power to

conduct an examination of persons relevant to

an investigation.


Inquiry, although many of the reforms proposed

are individually minor, cumulatively their

implementation would significantly enhance

APRA’s resolution toolkit and align APRA’s crisis

resolution powers more closely with the Key

Attributes. Each of the proposals would be devised

with strict legal triggers and safeguards designed

to ensure that the augmented powers would only

be exercised in appropriate circumstances and

when feasible recovery actions by the institution

are unlikely to succeed. The vast majority of these

powers also have no compliance cost for industry;

the powers are only relied upon when an

institution is facing acute financial distress.

Ensuring APRA’s powers to deal with a distressed

institution are robust and effective is therefore a

low-cost investment in helping to ensure the

safety of the financial interests of beneficiaries of

regulated institutions, and in the stability of the

financial system more broadly.


Pre-planning and pre-positioning (page 3-14)



Invest more in pre-planning and pre-positioning for financial failure.

A comprehensive set of crisis management powers

is necessary, but not sufficient, for dealing with a

failed or failing financial institution. To be truly

effective, statutory powers must be combined

with regular and robust contingency planning, by

both the public sector authorities and regulated

institutions, and appropriate pre-positioning.

During the global financial crisis, many financial

institutions were insufficiently prepared to adopt

and implement recovery actions – often across

multiple business lines and countries – to promptly

address the severe capital depletion and liquidity

shortages they encountered. Public sector

authorities also found themselves ill-equipped to

deal with the scale of the problems they faced,

other than by providing significant public sector

support. Consequently, recovery and resolution

planning has become central to international

discussions on measures for reducing the impact

of failure.

‘Recovery planning’ refers to a regulated

institution developing its own contingency plans to

demonstrate that it has identified a range of

plausible actions available to it such that it could

recover from a severe financial shock without the

need to seek public sector support. In the

Australian context ‘resolution planning’ refers to

planning by the public sector for how it would deal

with a failing financial institution in such a way as

to minimise the economic cost of the failure.


Inquiry, APRA has been working with a number of

regulated institutions on recovery planning. APRA

started the process by completing a pilot

programme for the larger banks, and has recently

extended recovery planning to a number of

medium-sized ADIs. APRA is considering a further

extension to the larger general and life insurers in

due course. The recovery plans provided to APRA

under the pilot programme provide a starting point

for further work to develop credible recovery

actions across a range of scenarios. This work is at

a relatively early stage. More remains to be done

to develop robust and reliable recovery plans that

could be implemented in a timely manner under a

range of adverse scenarios.

In conjunction with the other CFR agencies, APRA

has also continued its work on general resolution

planning, by focusing on measures that would

enable a cost-effective resolution of a regulated

institution where recovery is not feasible. The

work has primarily involved exploration of

resolution options for a distressed ADI, funding

issues related to the FCS, including options for pre-

funding, and refinement of ADI crisis resolution

coordination procedures.


APRA is committed to enhancing its recovery and

resolution framework. In this context,

APRA intends that recovery planning will become a

permanent component of APRA’s supervision

activities.34 Further work is required to enhance

the credibility of recovery plans, and APRA expects

that the larger banks will continue to develop their

recovery plans in the context of their normal

stress-testing programmes and Internal Capital

Adequacy Assessment Process. This will include

the consideration of the pre-positioning steps that

could improve the likelihood of recovery,

particularly for recovery actions that would need

to be taken very quickly.

APRA is currently considering how best to engage

with industry on individual resolution plans.

International experience has shown that a useful

first step in developing individual resolution plans

is to collect data on critical economic functions

and shared services, as well as ascertaining the

internal dependencies between legal entities and

business units, and the quantum and location of

loss-absorbing capacity. This would help inform

possible resolution strategies for APRA, including,

for example, the preferred structure of any

transfer of business resolution.

Planning for adversity and potential failure is a

necessary investment for regulated institutions,

with minimal cost implications, as it ensures that

they have a robust risk management framework

for responding to a range of adverse financial

shocks. Many steps taken under the guise of pre-

positioning may involve costs, but may also have

broader business benefits (e.g. simplification of

corporate structures, rationalisation of licences

and improved understanding of contingent

commitments). One-off compliance costs such as

investment in IT and staff training should have

already been made during the development of

initial recovery plans, and are able to be

minimised depending on the degree of integration

and dovetailing with existing contingency plans.

34 APRA 2012, Insight, Issue 3.

During the resolution planning process, if APRA

were to identify any potential barriers to an

orderly resolution, it would need to consider

on a case-by-case basis whether a regulated

institution should implement specified

pre-positioning to improve its resolvability.

For example, it might be desirable for certain

business units that would be potentially saleable in

a resolution to be operated on a more stand-alone

basis, with independent access to IT resources or

funding sources.

As noted in the previous section, APRA does

not currently have an explicit power to direct an

institution to pre-position for resolution if

necessary. This statutory shortcoming would be

addressed through implementation of the

legislative changes proposed in the September

2012 Consultation Paper, Strengthening APRA’s

Crisis Management Powers. The costs and benefits

of restructuring measures to pre-position a

regulated institution for resolution are difficult to

quantify in the Australian context. The costs would

most likely depend on the complexity of the

institution’s business model, legal and

organisational structure, and the extent of any

changes necessary.35 APRA has not, to date,

explored these areas in any detail. If needed,

however, APRA would work closely with the

institution to consider practical options to achieve

the required pre-positioning at least cost.

35 By way of example of specific pre-positioning, based on

initial industry feedback, APRA estimates that the one-off implementation costs for complying with the single customer view requirements of Prudential Standard APS 910 Financial Claims Scheme for small institutions are likely to be less than $100,000. For the major banks such costs will be in the order of millions, depending on the scope of the IT changes necessary to be undertaken.


Capital requirements (page 3-16)



Further increase capital requirements on financial institutions considered to be systemically important domestically.

In light of the higher costs that their

failure would impose on the community,

the designation as a domestic systemically

important bank (D-SIB) is designed to ensure that

banks perceived to be too big to fail are subject to

more intense supervisory oversight and have

greater capacity to absorb losses, thereby

increasing their resilience to failure.

In line with the internationally agreed framework

for D-SIBs, APRA has put in place a higher capital

requirement for D-SIBs in Australia effective from

2016.36 The additional D-SIB capital requirement is

a tool supporting APRA’s intensive supervision

approach for the largest institutions.

APRA conducted a range of quantitative

and qualitative analyses to inform the

establishment of this requirement for Australia,

but acknowledges that there is significant room for

judgement in calibrating a capital surcharge for a

D-SIB. The one per cent surcharge adopted by

APRA is in line with peer countries such as Canada

but, as noted in the Interim Report, is at the lower

end of the global spectrum. On the one hand, it is

clear that the largest Australian banks are more

systemic in a domestic context than the largest G-

SIBs are in an international context. On the other

hand, a key factor in determining the level of the

surcharge was APRA’s more conservative approach

to the measurement of capital adequacy relative

to international minimum standards. These local

adjustments already tend to impact the largest

banks more acutely relative to smaller institutions.

The Interim Report indicates that higher regulatory

capital requirements could be used as a tool to

reduce the funding advantage larger ADIs have due

to the perception of these institutions being too

big to fail, and as a means of enhancing the

competitive positon between smaller and larger

36 APRA 2013, Domestic systemically important banks in

Australia, December.

ADIs. While there may be a case for a higher D-SIB

surcharge for these reasons, it would need to be

considered in conjunction with other potential

policy responses being canvassed by the Inquiry

which may also affect the largest banks (e.g.

higher IRB risk weights or requirements for

increased loss-absorbing capacity).

Any proposal for a higher D-SIB surcharge should

also consider whether the increased requirement

need be met by CET1 capital, or might be met by a

wider range of capital instruments. If the Inquiry is

more concerned about reducing the impact, rather

than the probability, of a D-SIB failure, a Tier 2 or

loss-absorbing capital requirement for D-SIBs

might be preferable to increasing further the

CET1 requirement.

APRA does not rule out increasing the higher loss

absorbency requirement applying to D-SIBs in the

future. Consistent with its approach to

determining capital adequacy in general, APRA will

continue to monitor the calibration of the D-SIB

surcharge in light of domestic and international

developments. APRA’s stress-testing programme

will also provide insights into the appropriate level

of capital for different types of ADIs.

Insurers are less likely to be a source of systemic

risk than ADIs and international thinking is still

evolving on how the systemic impact of an

insurance failure should be measured. APRA

therefore intends to monitor international

developments in this area, and will consider any

need to extend the domestic SIFI framework to

cover insurers in due course.


The Financial Claims Scheme (page 3-18)



Modify the FCS, possibly including simplification, lowering the insured threshold or introducing an ex ante fee.


What measures could be taken to simplify the FCS with minimal burden on industry, while still ensuring the effectiveness of the scheme?

What is an appropriate threshold for the FCS guarantee of deposits?

Simplification

APRA is the administrator of the FCS for ADIs and

general insurers. For ADIs, APRA sets prudential

standards for the payment, reporting and

communications associated with an FCS

declaration, as well as standards to establish a so-

called ‘single customer view’. However, the

fundamental structure of the FCS (for both ADIs

and general insurers) is set out in primary

legislation and associated regulations.37

There is some scope to streamline the ADI FCS

without undermining its effectiveness through

proposals that have the potential to reduce the

regulatory burden for the industry without having

a material impact on APRA’s ability to administer

the FCS. Possible streamlining options are set out

below, although each of these options would

require amendments to legislation to enable them

to be implemented.

Simplify the calculation of the FCS

entitlement. The starting point for calculation

of the FCS entitlement in respect of a

protected account is the balance shown in the

ADI’s system at the time of declaration.

Several adjustments then need to be made

under subsection 16AF(1) of the Banking Act,

including to take into account accrued

37 The legislative framework for the FCS for ADIs resides in

Part II Division 2AA of the Banking Act and for general insurers resides in Part VC of the Insurance Act. There are also provisions relevant to the FCS in the APRA Act 1998, Financial Claims Scheme Levy (ADIs) Act 2008 and Financial Claims Scheme Levy (General Insurers) Act 2008. Provisions relevant to the administration of the FCS are included in the Banking Regulations 1966 and Insurance Regulations 2002.

interest, fees, charges and duties payable and

withholding tax components. This level of

complexity may be inconsistent with the

general objective of the FCS, which is to

rapidly and readily resolve the smaller deposit

claims of a failed ADI. It should be noted,

however, that given much, and in some cases

all, pre-positioning work has already been

completed by ADIs, development costs savings

from such simplifications may now be limited.

Clearance of transactions. When calculating a

protected account-holder’s entitlement, an

ADI must also make adjustments for the

clearance of transactions that occurred in a

specified period before the declaration of the

FCS. The Banking Regulations 1966 prescribe

this period as five business days even though

current industry practice is to clear most

transactions within three business days.

Reducing this period in the Regulations to

three business days would reflect current

industry practice and could help reduce pre-

positioning costs for the FCS.

Reducing the reporting burden in relation to

withholding tax. Under section 16AHA of the

Banking Act, APRA must report separately any

interest paid and applicable withholding tax to

the protected account-holder and to the

Australian Taxation Office (ATO). Reducing

this APRA reporting requirement could lower

the pre-positioning costs for ADIs under the

FCS, especially as there are also separate

reporting requirements in place between the

liquidator and the ATO.


Automatic activation of the FCS. Currently,

under the Banking Act and the Insurance Act,

the Minister has discretion as to whether the

FCS should be declared for an ADI or a general

insurer. Amending both Acts to provide for

automatic FCS activation would create

certainty for depositors and eligible

policyholders and claimants that they are

protected by the FCS. Under this proposal,

where an ADI or general insurer has liabilities

covered by the FCS, the FCS would be

activated automatically either at the time that

APRA applies to the Court for the winding up

of an insolvent ADI or general insurer or at the

time that the Court issues a winding-up order.

The Government has previously consulted on

proposals for streamlining the FCS provisions in the

Insurance Act. These proposals, should they be

implemented, would reduce compliance costs of

the FCS for general insurers, based on

amendments to the ADI FCS and APRA’s

experience of administering the Scheme for one

general insurer. The following two proposals would

have the most direct impact on streamlining the

Scheme and are discussed in more detail in the

Treasury’s 2012 Discussion Paper:38

Interim payments. Enabling APRA to make

interim payments to claimants under the FCS

would reflect industry practice and reduce

administration costs for APRA that are

subsequently levied on the industry. This may

be appropriate, for example, where an insurer

has admitted liability in respect of a personal

injury claim, but the exact quantum of the

claim is not known for many years; and

Cut-through payments. Where a policyholder

is in liquidation and there is a third party with

entitlements to an insurance policy, allowing

cut-through payments to the third party would

remove the need for APRA to negotiate with

liquidators to ensure that the payouts are

distributed to the claimants. This would

reduce the administration costs for APRA, and

thus the levy imposed on the industry.

38 The Treasury 2012, Strengthening APRA’s Crisis

Management Powers, September. These measures to streamline the FCS for general insurers did not raise any material industry concerns in the consultation.

Threshold guarantee of deposits

There are no strong reasons to change the insured

threshold for the ADI FCS. In 2011, the CFR advised

the Government that the FCS limit be set between

$100,000 and $250,000. The Treasury’s subsequent

RIS considered that a threshold of $250,000 would

be consistent with the identification of retail

depositors elsewhere in Australia’s prudential

regime.39 While higher than some jurisdictions, the

ratio between the FCS limit and Australia’s per-

capita GDP is by no means an outlier when

compared to deposit insurance caps in other

jurisdictions. Whatever the threshold, APRA notes

that Australia’s general depositor preference

regime offers additional protection in liquidation

to depositors whose account balances exceed the

FCS coverage limits.

Ex ante funding

When the IMF reviewed Australia’s financial system

in 2012, one of its high-priority recommendations

was to re-evaluate the merits of ex ante funding

for the FCS, with a view to converting it to an ex

ante funded scheme. The CFR considered this issue

in March 2013 and recommended to the

Government at that time that an ex ante funding

model for the FCS should be introduced in

Australia.40 An ex ante funding model is consistent

with the principle of ADIs paying for the benefits

of Government guarantees and would, at least in

part, compensate the Government for the risks of

providing such guarantees. It would also, if

appropriately segregated from broader

Government finances, build up a fund to assist in

meeting any future resolution costs. There could

be considerable benefits in being able to use such

a resolution fund to support alternative resolution

strategies to FCS payout in some circumstances,

such as transfers of business.

39 The Treasury 2011, Post-Implementation Review

and Regulation Impact Statement: Financial Claims Scheme, August.

40 Refer to the Government’s Economic Statement for August 2013, page 33.


Ring-fencing (page 3-20)



Ring-fence critical bank functions, such as retail activities.


Is there a case for introducing ring-fencing in Australia now, or is there likely to be in the future?

If ring-fencing is pursued, what elements should be protected and from what risks? For example, should deposit-taking functions be protected from proprietary trading. Is one of the models used overseas appropriate for Australia?

How ‘high’ should any ring-fence be? Do ring-fenced activities need to occur in entirely separate financial institutions, or could they be part of a group structure that has other business activities? Within a group, what level of separation would be necessary?

Are there ways to achieve the same benefits as ring-fencing without the costs of structural separation?

There does not appear to be a strong case for

introducing a general ring-fencing requirement in

Australia. The largest Australian ADIs largely retain

a traditional commercial banking business model,

dominated by retail and corporate lending.

Relative to many of the large global banks with

universal banking models, most Australian banks

have a relatively low exposure to higher risk

investment banking business, and undertake only

modest proprietary trading activities.

Ring-fencing proposals such as those of Vickers

(United Kingdom) and Liikanen (European Union)

are primarily targeted at universal banks with a

much higher proportion of volatile trading

exposures than has traditionally been conducted

by Australian banks.41 The Inquiry notes that, as a

result, establishing ring-fencing requirements in

Australia at this point in time, while costly, would

nevertheless be less costly than if it were to occur

at a time in the future when Australian ADIs had a

greater involvement in a broader range of

activities. However, the need for such a pre-

emptive ring-fencing requirement is lessened by

current and planned regulatory policy settings,

which will help limit the extent to which

41 United Kingdom Independent Commission on Banking

2011, The Vickers Report & Parliamentary Commission on banking standards, and European Commission 2012, Report of the European Commission’s High-level Expert Group on Bank Structural Reform (Liikanen Report).

Australian ADIs might be encouraged to shift to a

universal banking model:

amendments to the market risk regime in

the Basel capital framework will reduce

incentives for excessive growth in trading

businesses;

APRA’s existing capital framework

effectively insulates ADIs from the risks of

commercial and non-banking financial

institution investments by requiring them to

be funded by equity; and

Prudential Standard APS 222 Associations

with Related Entities requires an ADI to

have in place systems, policies and

procedures to manage, monitor and control

all forms of risks arising from its

associations with other members of a group,

not just those arising from direct financial

dealings with group members.


Unlike ring-fencing proposals being pursued

elsewhere, APRA’s longstanding approach has been

to avoid prescribing the particular businesses or

products that a regulated financial group may be

involved in, or imposing particular corporate

structures. In dealing with the risks that emanate

from financial groups, APRA’s philosophy has been

to allow regulated groups a large amount of

freedom to conduct their affairs as they see fit,

provided they can demonstrate appropriate

governance arrangements, risk management

capabilities and capital strength.

APRA’s requirements regarding an appropriate

framework for the supervision of financial

conglomerates were recently published.42 The

framework is founded on four basic requirements:

there must be a robust governance

framework that is applied throughout

the group;

intra-group exposures, and external

aggregate exposures, must be transparent

and prudently managed;

a group must have an effective group-wide

risk management framework in place; and

a group must have sufficient capital such

that the ability of its APRA-regulated

institutions to meet their obligations is not

adversely impacted by risks emanating from

elsewhere in the group.

APRA’s risk-based, group-level supervision regime

is designed to ensure that any higher risk

activities, whether in the ADI itself, its

subsidiaries, or other group members, are subject

to ongoing prudential monitoring and review. This

approach is more prudent and less interventionist

than ring-fencing. Countries that have embarked

on a ring-fencing approach as a solution to risks

that became evident during the global financial

crisis have also found it complex and costly to

define and implement. Although it is too early to

draw any conclusions, it is not clear that the

jurisdictions undertaking ring-fencing and

42 APRA 2014, Media release: APRA releases framework

for supervising conglomerates but defers implementation, August.

associated techniques will in fact gain substantial

systemic stability benefits, given that there may

still be considerable risk of contagion between

activities inside and outside the ring fence.

Ring-fencing may nevertheless be beneficial in

some situations; in particular, where there are

substantial risks (including from non-financial

businesses) or significant organisational complexity

that might impede supervision or an orderly

resolution. In particular, resolution frameworks are

typically designed with conventional business

models in mind; the existence of complex

structures and unusual businesses may impede the

ability of the resolution authority to act in an

expeditious manner. Where ring-fencing is being

proposed to facilitate resolution, it is more

appropriate to address these issues on a case-by-

case basis and for this to be reviewed regularly as

a bank’s business evolves, rather than establishing

a single structural ring-fencing model in

legislation. The resolution powers discussed above,

if implemented, would provide the capacity to

deal with this issue more effectively.


Assess the prudential perimeter (page 3-29)



Establish a mechanism, such as designation by the relevant Minister on advice from the Reserve Bank of Australia (RBA) or the Council of Financial Regulators (CFR), to adjust the prudential perimeter to apply heightened regulatory and supervisory intensity to institutions or activities that pose systemic risks.


Is new legislation the most appropriate mechanism to adjust the prudential perimeter to respond to systemic risks, or could a more timely mechanism be of benefit? What alternative mechanisms could be used?

What accountability processes would be necessary to accompany any new mechanism?

What criteria could determine when an institution or activity was subject to heightened regulatory and supervisory intensity?

The current perimeter of prudential regulation is

defined by the Australian Parliament in the

Industry Acts and the APRA Act 1998 (APRA Act)

that establish the scope and objectives of APRA’s

supervision. Thereafter, APRA operates

independently to supervise the relevant entities in

line with its statutory mandate and objectives.

APRA’s view is that this division of responsibilities

remains appropriate.

The shadow banking sector, or the non-bank

financing sector, is not large in Australia and very

little of it is currently a particular source of

systemic concern. There are institutions operating

outside the regulated ADI industry that take funds

from the public and provide credit (e.g. RFCs).

New entities and business models may also

emerge over time, sometimes with the aim of

avoiding regulation.

APRA is therefore alert to risks emerging at the

edge of the regulatory perimeter. Where the risks

associated with a particular type of business (or

institution) generate a material degree of concern,

APRA would discuss the risks with the other CFR

agencies and consider if any further action is

needed.43 Where necessary APRA, individually or

jointly with the other CFR agencies, could

recommend to the Government that the

regulatory perimeter be adjusted, on systemic risk

43 The RBA provides a regular update to the CFR on

shadow banking.

or other grounds. It would then be a matter for

the Government as to whether it wishes to act

on this advice.

Legislation remains the most appropriate

mechanism to adjust the prudential perimeter.

Amendments to the regulatory perimeter on the

grounds of systemic risk are, as acknowledged in

the Interim Report, relatively rare and likely to

remain so. Further, any new sector or activity

brought within the scope of prudential regulation

may require additional regulatory powers, or

indeed a completely different regulatory regime,

from those applied to the industries that APRA

already supervises. The transition to a new

regulatory framework and supervisory

environment will require considerable time and

consultation. In these circumstances, even a more

flexible approach to adjusting the prudential

perimeter would be unlikely to result in

substantially faster implementation.


A pertinent example that may challenge regulators

and the definition of the regulatory perimeter is

the rise of technology-based payment

mechanisms, which are increasingly provided by

non-bank entities. Although these payment

facilities have initially been relatively narrowly

focused, the potential exists for them to expand

over time. Attempts to bring such businesses under

local regulatory oversight, particularly if they are

based overseas or have no clear geographic nexus

to Australia, would likely require revision to

statutory powers and supervisory practices.

There may also be alternatives to prudential

regulation to tackle systemic risks in institutions

beyond the perimeter:

most, if not all, participants in the financial

sector interact regularly with regulated

institutions. APRA may impose measures on

regulated institutions and hence indirectly

influence the behaviour of unregulated

entities and effectively manage the activity

giving rise to the systemic risks;

prudential regulation may not be the most

appropriate response to some forms of

systemic risk. Conduct regulation or other

market measures may better address the

threat. For example, the move to increased

central clearing of derivatives since the

financial crisis is designed to reduce systemic

risk. This change has not been implemented

by changes to prudential regulation; and

similarly, the RBA and ASIC also regulate parts

of the financial system. Where an entity

outside the regulatory perimeter appears to

pose a systemic threat, it may be more

appropriately supervised alongside more

similar entities within the purview of these

other members of the CFR. In such cases,

heightened regulatory and supervisory

intensity by other regulators would be a more

appropriate response to the systemic risk than

prudential regulation by APRA.

An example: Shadow banking

As noted above, Australia does not have a large

non-bank financing sector. However, there are

some firms that are not regulated as ADIs but

nonetheless accept funds from the public and

provide credit. These very limited forms of shadow

banking are outside the prudential perimeter.

APRA’s initial submission describes the role of RFCs

which have, for historical reasons, been granted

exemptions from the need to be authorised as

ADIs. APRA has been consulting on proposals to

amend these exemptions so that, for all practical

purposes, investments with RFCs are not able to

be used for transactional banking activities. APRA

is currently finalising its proposals in this area,

which will enable it to more effectively enforce

the existing prudential perimeter around

‘banking business’.


Additional macroprudential powers (page 3-30)



Introduce specific macroprudential policy tools.


Are there specific macroprudential tools that Australia should adopt to manage systemic risk?

What agency or agencies should have these macroprudential tools?

APRA views macroprudential policy as subsumed

within the broader and more comprehensive

financial stability policy framework, under which

APRA and other Australian financial regulators

consider a system-wide view an essential part of

effective prudential supervision, inextricable from

the supervision of individual institutions.44 From

time to time, this may require changes to

prudential policy settings or supervisory

interventions that could be considered

‘macroprudential’ in nature. This approach has as

its goal the resilience of the financial sector: it

recognises that financial cycles are inevitable, and

seeks to use prudential tools to ensure that

regulated institutions build up their financial

resilience to future shocks or downturns. It may

also have broader, indirect effects, but these are

not the primary policy purpose.

Another, more ambitious view of macroprudential

policy is for prudential interventions to be used to

attempt to manage financial or economic cycles.

The goal of such an approach could include

addressing concerns about asset prices or

household balance sheets. Such an approach raises

questions about which arm of government should

be responsible for decisions about instruments

used to manage these risks, as such decisions

become part of the realm of economic policy even

where they involve prudential tools imposed on

regulated institutions. APRA agrees with the

Interim Report, which considered that Australia

44 APRA and Reserve Bank of Australia 2012,

Macroprudential Analysis and Policy in the Australian Financial Stability Framework, September.

should be cautious about adopting an ambitious

approach while empirical evidence of their

effectiveness remains limited.

Consideration of, and response to, aggregate

industry risks have long been part of APRA’s

supervisory framework and do not require new

tools or powers. For example:

In 2003 APRA made significant adjustments to

the risk-weighting of residential mortgage

exposures and the capital regime for lenders

mortgage insurers in response to stress testing

of ADIs’ housing loan portfolios.45

As noted in APRA’s initial submission to the

Inquiry, APRA and the RBA have already

adopted a number of measures to help contain

risks in the current Australian housing lending

market. APRA is working closely with ADIs to

ensure they maintain prudent lending

practices, including issuing a draft prudential

practice guide for consultation.

Should APRA determine that a more

prescriptive approach is necessary to mitigate

housing lending risks, it can use existing

standard-making powers. However, regulator-

imposed lending limits and loan underwriting

criteria can have unintended consequences

45 Refer to APRA 2003, Proposed Changes to the Risk-

Weighting of Residential Mortgage Lending, November, and APRA 2004, letter to all ADIs (excluding locally licensed branches of foreign banks), Changes to the Risk-Weighting of Residential Mortgage Lending – AGN 112.1 Attachment C, 16 September.


and be circumvented by market

developments. While regularly assessing the

need for such policies, APRA’s preference

generally is to remain vigilant in targeting

imprudent lending practices through

proactive supervision.

APRA may adjust capital requirements

applying to lending to specific sectors, such as

residential or commercial property. Under

Basel II, ADIs approved to use the IRB approach

to credit risk must apply a minimum LGD for

residential mortgage exposures that is greater

than that of the Basel framework. Some other

countries have recently adopted similar

measures for macroprudential purposes.46

APRA conducts regular stress tests to

understand system-level vulnerabilities in the

Australian banking sector.

The Basel III reforms introduced an additional

explicit macroprudential tool: the countercyclical

capital buffer. The Basel Committee describes the

primary aim of the countercyclical capital buffer

as supporting the resilience of the financial

system: to ensure the banking system has a buffer

of capital to protect it against future potential

losses, following a build-up of system-wide risk.47

The countercyclical capital buffer, should it be

activated, effectively increases aggregate capital

requirements for all ADIs. In order to ensure that

the banking system has a buffer of capital to

protect it against further potential losses, APRA

could deploy this tool in periods when excess

aggregate credit growth was judged to be

associated with a build-up of system-wide risk.

APRA would expect to consult closely with the

RBA, and the other CFR agencies, in implementing

a countercyclical capital buffer requirement.

46 Refer, for example, to the discussion of the risk-weight

floor introduced by the Swedish authorities in Finansinspektionen and Sveriges Riksbank 2013, Minutes of the meeting of the Council for Cooperation on Macroprudential Policy, October.

47 Basel Committee on Banking Supervision 2010, Basel III: A global regulatory framework for more resilient banks and banking systems, December (revised June 2011).

APRA’s existing tools are appropriate to implement

macroprudential policies which, like the

countercyclical capital buffer, are aimed at

increasing the resilience of the financial system,

rather than at macroeconomic objectives. The use

of supervisory tools in this manner is entirely

consistent with APRA’s prudential mandate.


Stress testing (page 3-31)



Australian regulators make greater use of stress testing with appropriate resourcing.

Stress testing is a forward-looking analytical tool,

useful for both supervisors and APRA-regulated

institutions in understanding and managing risk.

There are clear benefits in systematically

considering severe but plausible scenarios that

challenge a regulated institution’s viability, and to

consider the impact of these scenarios at the

financial system level.

As detailed in the Interim Report, the IMF’s 2012

Financial Sector Assessment Program (FSAP)

review of Australia recommended that APRA

devote more resources to stress testing. Since

then, APRA has increased resources for stress

testing as part of a comprehensive strategy,

including specialist resources within a central

coordination team, although not to the same

extent as other regulators that have made stress

testing one of their main supervisory activities.

APRA has also invested in specialist training for

frontline supervisors, to ensure that stress testing

is an integrated part of prudential supervision

rather than a stand-alone exercise. Stress testing

is intended to support and enhance prudential

analysis and supervision, rather than operate as an

adjunct to it.

Central to this strategy for stress testing is a

regular cycle of APRA-led industry stress tests.

APRA has conducted industry stress tests on the

banking sector, with recent major exercises in

2009 and 2011-12. APRA is currently in the process

of conducting an industry stress test focused on

risks that may emerge in a severe economic and

housing market downturn. As in previous years,

the stress tests will be used to identify

vulnerabilities, assess risks and resilience, and as

a catalyst to improve stress-testing capabilities

across the industry. Given the inherent

uncertainties of stress testing, APRA does not set

prudential capital requirements on the basis of

specific industry tests, and does not disclose the

results of individual institutions. The scenarios,

impact and results at a system level from industry

stress tests have been, and will continue to be,

presented publicly.

In addition to industry stress testing, APRA has also

increased its focus on regulated institutions’ own

stress-testing practices. Ensuring that institutions

build and improve their own stress-testing

capabilities is a key part of APRA’s approach.

Regulated institutions are expected to consider

stress test results in their own capital planning and

risk management, and to build effective internal

capabilities. This includes strong internal

governance, scenario development, reliable data

and robust modelling. APRA has conducted offsite

and onsite reviews of institutions’ stress-testing

programmes, and will continue to invest attention

in this critical area of capital management.

Stress testing can also provide a perspective on

financial stability at a systemic level. APRA

therefore works closely with the RBA on a ‘top-

down’ stress-testing framework at the aggregate

industry level, as well as conducting internal

research and methodologies for stress testing at a

‘bottom-up’ level. Developing these capabilities in

tandem will provide a stronger framework and

greater flexibility to assess vulnerabilities across

different risks and segments of the industry.

Increasing the speed and depth with which these

modelling capabilities are developed would either

require additional resources or careful cost-benefit

analysis of the trade-offs involved in

reprioritisation through diverting resources from

other activities.


Calibrate the prudential framework (page 3-41)



Maintain the current calibration of Australia’s prudential framework.

Calibrate Australia’s prudential framework, in aggregate, to be more conservative than the global median. This does not mean that all individual aspects of the framework need to be more conservative.


Is there any argument for calibrating Australia’s overall prudential framework to be less conservative than the global median?

APRA welcomes the Inquiry’s conclusion that the

historical approach to calibrating Australia’s

prudential framework has held the Australian

banking system in good stead, particularly during

the global financial crisis. The current calibration

of the Australian prudential framework remains, in

APRA’s view, broadly appropriate. By their nature,

capital adequacy and other prudential

requirements require regular review to ensure

they remain fit for purpose, but there is little

evidence that current calibrations are materially

at odds with APRA’s statutory objectives.

As noted in the following section, a direct

comparison of ADI capital ratios internationally is

difficult. Evaluating the calibration of the broader

prudential framework is even more complex.

While Australian capital requirements are, in some

areas, more conservative than international

requirements, other countries have also adopted

additional measures that are at this point not part

of the Australian framework. As a result,

comparing the overall calibration of the prudential

framework is extremely challenging.

APRA’s assessment is that, on the whole,

the Australian prudential framework remains

towards the more conservative end of the

international spectrum. Since 2013 the gap

between Australia and the global median has likely

narrowed, given the impact of the post-crisis

reforms has been felt far more acutely in a

number of other jurisdictions. For example, a

number of the Basel III capital reforms introduced

requirements into the international framework

that were the same or similar to those that had

been required in Australia for many years. APRA

has also not seen fit to follow the United States,

Canada and the United Kingdom in introducing a

leverage ratio (at least until such time as

international deliberations are complete) or the

ring-fencing requirements that are being imposed

on many international banks in other jurisdictions

(e.g. the Volcker rule in the United States, the

Vickers proposals in the United Kingdom, and the

Liikanen proposals in the European Union).

There are sound reasons why the Australian

prudential framework should be calibrated above

the global median: the concentrated nature of the

Australian banking system, its dependence on

offshore borrowings, and the Australian economy’s

openness to international economic shocks. Many

peer regulators have also introduced local

requirements over and above the global

minimums: the conservatism of Australia’s

framework is not an outlier in international terms.

Furthermore, as noted in the Interim Report,

there is little evidence that this approach has

placed Australian ADIs at a significant

competitive disadvantage.


Australian institutions benefit in their international

dealings from being domiciled in a country with a

highly regarded prudential regime. Markets, rating

agencies, and offshore regulators all give credit to

the strength of APRA’s prudential framework when

assessing the strength of Australian institutions.

Any proposal to shift the Australian prudential

framework in such a manner that it became less

conservative than the global median, particularly

for those banks that seek access to international

capital and funding markets, would be short-

sighted. There is little evidence to suggest such a

move would generate material short-term benefit.

The largest Australian banks enjoy some of the

world’s highest credit ratings, and some of the

world’s highest share market capitalisations and

market-to-book ratios; this would not necessarily

be the case under a weaker regime. In the long

run, a diminution in the robustness of the

prudential framework would reduce the resilience

of the Australian financial system to shocks, and

risk a repeat of the extraordinarily painful lessons

learned by other jurisdictions from the global

financial crisis.

International comparability of APRA’s prudential requirements

(page 3-42)



Develop public reporting of regulator-endorsed internationally harmonised capital ratios with the specific objective of improving transparency.

Adopt an approach to calculating prudential ratios with a minimum of national discretion and calibrate system safety through the setting of headline requirements.


Would adopting a more internationally consistent approach to calculating capital ratios materially change Australian banks’ cost of accessing funding?

How would using minimal national discretion distinguish between prudent banks that hold capital as currently defined and those that rely on less loss absorbing capital?

How might APRA need to adjust minimum prudential requirements to ensure system safety is not altered if using minimal national discretion in calculating prudential ratios?

In implementing the Basel framework in a

manner suitable to the Australian environment,

APRA considers a number of objectives: adequacy,

incentives and comparability. Ensuring ADIs have

adequate capital is the primary goal of the capital

framework: that is, APRA sets the aggregate

outcome for each ADI at an amount of capital

sufficient to ensure that the ADI will meet its

obligations even under severe but plausible

adversity. Achieving this outcome efficiently is

best accomplished by ensuring the capital

adequacy framework is risk-based, and therefore

provides appropriate incentives for ADIs to manage

their affairs in a prudent manner. APRA also sees

value in appropriate comparability of capital

ratios, particularly for the largest banks operating

internationally. APRA optimises comparability by

diverging from the internationally agreed

minimum framework only when there are well-

founded prudential reasons for doing so. Any

such divergences are extensively consulted on

and disclosed.

APRA has typically taken a more conservative

approach to the measurement of ADI capital

adequacy relative to international minimum

standards. This has been the case for many years

and continues the approach adopted by the RBA

when it had responsibility for the prudential

supervision of banks prior to APRA’s creation.


This approach may inhibit capital comparisons for

Australia’s internationally active ADIs to some

degree. However, as discussed further below, it is

not clear there has been any material cost that

would justify adoption of a different approach.

The Australian approach is also far from unusual.

The standards of the Basel Committee are

intended to serve as minimum standards: there

has never been an intention by the international

standard-setters to prevent individual jurisdictions

from adopting stronger standards where they

deem it necessary. Many jurisdictions have, as a

result, adopted domestic measures that are more

conservative than the internationally agreed

minimum standards. National authorities are also

increasingly making use of macroprudential

adjustments within the regulatory framework,

which can lead to additional changes to capital

requirements and risk weights in response to

increased levels of risk. As a result of these

additional requirements imposed by national

authorities, computing a precise ‘internationally

harmonised’ capital ratio is not practically

possible. A recent study commissioned by the

Australian Bankers’ Association, which attempts to

provide truly comparable capital ratios, only

serves to emphasise this point.48

In addition to disclosing their capital ratios based

on APRA’s minimum requirements, APRA has no

objection to ADIs reporting a capital ratio based on

international minimum requirements. Indeed, as

the Inquiry has already noted, APRA has already

committed to work with the industry to develop

such a reporting regime. A capital ratio calculated

by stripping out the impact of APRA’s national

adjustments, and using the least conservative

requirements available under the Basel

framework, would help identify and measure the

impact of APRA’s exercise of national discretion in

many areas (some, though, may still be

unobservable). Such a calculation, however, would

not generate a capital ratio that is harmonised

with those reported by banks from other

jurisdictions, unless similar adjustments were

made to the capital ratios of other banks for the

idiosyncrasies in their domestic frameworks. In the

48 Australian Bankers’ Association 2014, International

comparability of capital ratios of Australia’s major banks, August.

absence of such adjustments, calling such a ratio

‘internationally harmonised’ is a misnomer.

Nor would such a calculation inform investors

about the true capital buffer an ADI holds.

Investors are interested in capital ratios to make

two basic comparisons: against other banks and

against minimum requirements. The discussion in

the Interim Report focuses on the potential to

improve investors’ ability to make the first of

these comparisons. But equally critical is investors’

understanding of the capital buffers ADIs hold

against various minimum regulatory requirements.

An apparently healthy capital ratio measured on

an ‘international minimum’ basis is of limited

value in understanding how close or far a bank is

from breaching its minimum requirements, and

hence from incurring some form of regulatory

intervention. Only by comparing the bank’s capital

ratio, calculated under local requirements, can

this be understood. For this reason, in developing

disclosure requirements for bank capital ratios to

promote transparency, the Basel Committee

elected to require banks to report in terms of their

local implementation of Basel III.

The only internationally consistent approach to

calculating capital ratios would be to calculate

ratios using international minimum requirements

as a baseline. The Basel Committee debated this in

developing its capital adequacy disclosure

standards, but rejected the notion on the basis

that it may well mislead investors as to the true

nature of a bank’s financial health when local

authorities have seen the need to impose

additional requirements, including for

macroprudential reasons, to respond to domestic

risks. The Basel framework also includes

discretions that allow each member jurisdiction

the ability to tailor the regime to the

circumstances of its own banking market – in some

places, there is no definitive minimum standard

per se.

International investors appreciate that there are

differences in the ‘headline’ capital numbers

across institutions in different regulatory regimes

and understand that the largest Australian ADIs are

well capitalised. The largest differences, such as

those due to capital deductions, are already

disclosed. As the major banks remain among only a

small number of listed global banks with AA ratings

it is highly unlikely that any change in determining


capital sufficiency would have an impact on

Australian banks’ cost of funds. Equity investors

also seem to view the major banks more

favourably than many of their international peers:

the major banks’ market capitalisation is around

twice the book value of their equity, a broadly

similar ratio to their Canadian peers, but

significantly higher than British, American and

European banks (where the ratio is around one

times). Similar trends are observed in debt

markets, where the cost of default protection

against the major Australian banks is, on average,

lower than for large British, American and

European banks. Rating agency Standard & Poor’s

rates Australia as one of the five least-risky

banking systems of the 86 that they cover.49

Initiatives to improve comparability of capital

ratios need to be careful not to undermine the

broader objectives of the capital regime. To

achieve a given level of capital adequacy, APRA

can adopt one of two broad approaches:

simply adopt the minimum international

requirements for determining eligible

capital and establishing risk weights, and

calibrate the entire system using only the

minimum capital ratios; or

fine-tune the specific requirements within

the framework as needed, and maintain the

internationally accepted benchmarks for

minimum capital ratios (the most well-

known being the minimum capital ratio of

8 per cent).

Consistent with its strong belief in establishing

appropriate incentives by using risk-based

requirements, APRA has traditionally adopted the

second of these approaches.

APRA’s approach has a number of advantages:

rather than requiring additional capital

across all of an ADI’s assets, specific

adjustments can be targeted at (and only

at) specific risks, thereby promoting

efficiency within the capital framework;

comparability across ADIs is enhanced, and

competitive neutrality is maintained, as the

49 Standard & Poor’s 2014, Australian Banking Sector

Outlook: Ratings Resilience Anticipated For 2014, 11 February.

requirements fall on those ADIs where the

additional capital is most needed;

targeted adjustments enhance the

incentives within the capital framework to

ensure the prudent management of risk and

the maintenance of high-quality capital;

the adjustments are transparent and, with

appropriate disclosures, their impact can be

readily understood; and

the adjustments allow for the preservation

of the internationally well-known

minimum benchmarks.

The alternative approach of calibrating the entire

framework using only the minimum capital ratios

might marginally improve international

comparability. However, it would come at the cost

of a considerably less risk-sensitive regime. This

reduction in risk sensitivity would reduce both the

efficiency and effectiveness of the capital

adequacy framework. A less risk-sensitive regime

would also, perversely, be likely to place much

greater emphasis on APRA’s Pillar 2 adjustments to

ensure ADIs remain appropriately capitalised.

Because Pillar 2 adjustments are not disclosed,

this would undermine the very transparency and

consistency that the approach is designed to

achieve: investors would have less visibility of

where an ADI’s capital ratio stood relative to the

minimum requirements APRA has imposed.

As discussed above, the best approach to

improving the international comparability of

capital adequacy ratios, without compromising the

veracity of the measure, is through disclosure of

the impact of APRA’s policies. This approach is

similar to the Inquiry’s option of separately

reporting harmonised capital ratios, but

acknowledges that disclosure of a truly

comparable ratio is not possible without

international cooperation. APRA has implemented

the Basel Committee’s common disclosure

template for ADI capital adequacy information.

APRA is working with the industry on a reporting

template to further facilitate comparisons

between the capital ratios of Australian and

overseas banks.


Main differences in the application of the Basel framework APRA imposes a minimum LGD requirement on residential mortgage exposures of 20 per cent under the

IRB approach. This is imposed given the inability of the relevant ADIs to provide convincing estimates of

LGDs under a downturn scenario. As detailed in APRA’s initial submission, a number of other Basel

Committee member countries are making similar adjustments to IRB risk weights for housing lending,

reflecting concerns that modelling practices may not capture the full range of risks inherent within

housing markets.

For those ADIs that are accredited to use the advanced approaches to credit and operational risk, APRA

requires a mandatory (Pillar 1) capital requirement for IRRBB. This is consistent with the Basel II

framework that states that where supervisors consider that there is sufficient homogeneity within the

banking industry regarding the nature and methods for monitoring and measuring this risk, a mandatory

minimum capital requirement could be established.

Since 1990 banks’ holdings of other banks’ capital instruments in Australia have been required to be

deducted from capital for the purpose of calculating minimum capital ratios. A similar requirement for

deferred tax assets was introduced in 1991.50 This approach is based on two longstanding points of

principle: assets that rely on future profitability (of the ADI) or that are potentially uncertain in value

cannot be included in the calculation of capital, and regulatory capital cannot be used more than once in

the financial system to absorb losses. This policy continued with the implementation of Basel III. The

additional amount of capital is somewhat offset by APRA’s less conservative stance on certain holdings of

ADIs’ own capital instruments.

APRA has an additional deduction for certain capitalised expenses, such as capitalised software costs.

These exposures are classified as intangibles under Australian accounting standards and rely on the future

profitability of the ADI in order to realise their value. The requirement for deduction from capital is based

on a similar principle as that for deferred tax assets.

Requirements on boards (page 3-48)



Review prudential requirements on boards to ensure they do not draw boards into operational matters.

Regulators continue to clarify their expectations on the role of boards.


Is it appropriate for directors in different parts of the financial system to have different duties? For example, differences between the duties of directors of banks and insurers and trustees of superannuation funds. Who should directors’ primary duty be to?

50 Reserve Bank of Australia 1990, Press Release: Capital Adequacy: Bank’s Holdings of other Bank’s Capital Instruments,

90-24, 27 September, and Reserve Bank of Australia 1991, Press Release: Capital Adequacy: Future Income Tax Benefits, 91-19, 4 October.


Role of boards

As detailed in APRA’s initial submission,

requirements for sound governance are a core

element of APRA’s behavioural standards.

Experience consistently demonstrates the

importance of strong governance standards in

APRA-regulated industries. In the 1980s and 1990s,

severe problems in regulated institutions in

Australia were often the product of poor

governance and control frameworks. Until a

decade ago, however, APRA had little in the way

of prudential requirements relating to governance,

risk management and the role of the board.

Building on the lessons from a number of

significant losses by Australian institutions in

the early 2000s, raising governance and risk

management standards has been a priority for

APRA over most of the past decade. APRA’s focus

on this area has been validated by the experience

of the global financial crisis: shortcomings in

how boards met their responsibilities have been

identified as a material contributor to the

crisis that occurred. In the United Kingdom,

for example:

‘The crisis exposed significant shortcomings in

the governance and risk management of firms

and the culture and ethics which underpin

them. This is not principally a structural issue.

It is a failure in behaviour, attitude and in

some cases, competence.’51

It is sometimes asserted that APRA’s requirements

extend beyond those considered appropriate for

directors and thereby require board involvement in

operational matters that should generally be the

responsibility of senior management. This is not

APRA’s intent. Ultimately, boards of regulated

institutions are responsible for establishing an

appropriate governance regime within which the

institution’s risk and capital management can

effectively operate. While the Corporations Act

2001 (Corporations Act) establishes general

obligations for board directors and other officers

to act with care, diligence and in good faith, it

does not fully address all the essential elements of

good corporate governance in prudentially

regulated institutions, as identified in the Basel

51 Sants H. 2012, Chief Executive of the Financial Services

Authority, ‘Delivering effective corporate governance: the financial regulator’s role’, 24 April.

Committee’s Core Principles for Effective Banking

Supervision, the International Association of

Insurance Supervisors’ (IAIS) Insurance Core

Principles (for life and general insurance) and by

the FSB. These include requirements on matters

such as board composition and skills,

responsibilities for risk management, remuneration

principles and the roles of the Chief Risk Officer

and board committees.

APRA agrees that regulatory requirements should

not confuse or blur the delineation between the

role of the board and that of management. APRA

expects the board to provide oversight of key

aspects of policies and frameworks, and to

challenge management as appropriate. In light of

industry concerns, APRA is currently reviewing its

prudential requirements to identify areas that may

be perceived as leading to a blurring of duties.

This includes engaging with experienced directors

to hear firsthand how they think the current

framework can be improved.

The Interim Report notes that it may be possible

to identify areas where management could more

appropriately undertake certain obligations. It is

important that the Inquiry understands that, in

many cases, obligations imposed on boards are

designed to demonstrate that appropriate

oversight and challenge of management is

occurring. Delegating such responsibilities to

management may be ineffective or counter-

productive. Therefore, consideration may also

need to be given to additional external (third-

party) review to achieve the prudential objective.

Differences in board responsibilities

As detailed in the Interim Report, directors in

different parts of the financial system have

different duties. All directors have duties

under the Corporations Act, while some have

additional duties imposed on them by the relevant

Industry Acts.


In the case of superannuation, section 52A of the

SIS Act contains covenants which apply to the

directors of a corporate trustee of an RSE. These

provide that the directors must, among other

requirements, perform their powers and functions

in the best interests of beneficiaries. These duties

are expressed to override the Corporations Act

duties. Section 48 of the Life Insurance Act places

a similar duty on directors of life insurers to give

‘priority to the interests of owners and prospective

owners of policies referable to the fund’. Section

2A of the Insurance Act notes that the Act imposes

primary responsibility for protecting the interests

of policyholders on the directors (and senior

management) of general insurers, although the Act

does not include provisions in the same terms as

those of the SIS and Life Insurance Acts. The

Banking Act is silent on the requirements of

directors of ADIs in relation to depositors.

For superannuation and life insurance, the Industry

Acts are clear regarding the duty of directors to

fund members and policy owners respectively. In

both industries, the existence of the special

director duties can be seen as consistent with the

legal basis upon which the assets supporting

beneficiaries’ claims are held:

in the case of superannuation, the trustee

company - that is the RSE licensee - holds

the assets in trust on behalf of members.

The SIS Act makes clear as to whom trustee-

directors owe their duty of loyalty in relation

to those assets. APRA regards this as

fundamental to the integrity of the

superannuation system; and

the duties in section 48 of the Life Insurance

Act are closely related to the statutory fund

regime, which is intended to separate the

assets and liabilities referable to a class of

policy owners from the general assets and

liabilities of the life company. The directors of

a life company have a duty to see that the

company gives priority to the interests of

policy owners, with the statutory fund having

some resemblance to a trust.

In contrast, ADIs and general insurers are not

required to segregate assets and liabilities

referable to their customers.

The difference between directors’ duties under

the various Industry Acts also reflects the

difference in the nature of products provided to

beneficiaries. Investment-based products offered

by superannuation funds and life companies are

not (or not always) defined by readily verifiable,

quantitative obligations for a particular return or

benefit. In contrast, a deposit with an ADI is

offered at a specified rate of interest and general

insurance policies cover specified loss or damage

of, for example, property. In the case of

superannuation and life insurance, the objective is

for the trustee or life company director to strive to

maximise the rate of return (either generally, or in

relation to a given class of investments), and this

requires a greater emphasis on the best interest of

members or policyholders.52

In summary, the current requirements placed on

directors by the respective Industry Acts are in line

with differences in operational structure, and the

nature of the ‘promise’ contained in the

traditional products of each industry. Beyond that,

APRA’s requirements of directors are largely

harmonised within its prudential standards,

and further harmonisation of requirements of

directors in the relevant Industry Acts does not

seem warranted.

52 It is worth noting that directors of Responsible Entities

of managed investment schemes, which are also investment funds that have the purpose of maximising the rate of return, have similar duties to those required of directors of superannuation trustee companies and life insurance company directors. Refer to section 601FG of the Corporations Act.


Chapter 6 of the Interim Report: Consumer outcomes

Product rationalisation of ‘legacy products’ (page 3-87)




Government to renew consideration of 2009 proposals on product rationalisation of legacy products.

As detailed in APRA’s initial submission, legacy

products arise particularly in life insurance and

superannuation. In these industries, consumers

may purchase financial products that often last a

lifetime, even though the financial, taxation and

regulatory environment continually changes. Over

time, older products become expensive to

administer, particularly if they are no longer

offered, as the IT systems used to support the

product age and the corporate memory of the

product provider fades. Quite often, the legacy

products are no longer meeting the needs of

beneficiaries, but there is no effective means to

move these beneficiaries into newer, more cost-

effective products.

The Banks Report recommended that the

Australian Government, State and Territory

governments, APRA and ASIC should, in

consultation with industry stakeholders, develop a

mechanism for rationalising legacy financial

products.53 Its main purpose would be to remove

legacy products by transferring investors into

newer, more efficient products. Appropriate

safeguards can be designed so that this can be

done in such a way as to benefit both product

providers and their customers.

53 Regulation Taskforce 2006, Rethinking Regulation:

Report of the Taskforce on Reducing Regulatory Burdens on Business, page 103.

Progress in this matter has stalled since 2010, yet

the problem associated with legacy products will

arguably become greater the longer the issue

remains unaddressed. APRA strongly supports the

resumption of work on this issue. It would help

mitigate the increasing operational risk that such

products create in the superannuation and life

insurance industries, as well as reduce the

operational costs that financial institutions, and

ultimately consumers, are currently incurring.


Chapter 7 of the Interim Report: Regulatory architecture

Regulatory burden (page 3-97)


Is there evidence to support conclusions that the regulatory burden is relatively high in Australia when considered against comparable jurisdictions?

Are there examples where it can be demonstrated that the costs of regulation affecting the financial system are outweighing the benefits?

Are there examples where a more tailored approach could be taken to regulation; for example, for smaller ADIs?

Are there regulatory outcomes that could be improved, without adding to the complexity or volume of existing rules?

Could data collection processes be streamlined?

If new data is required, is there existing data reporting that could be dropped?

Instead of collecting new data, could more be made of existing data, including making more of it publicly available?

Regulatory burden

The Interim Report notes that measuring whether

benefits of regulation outweigh the costs is

challenging, given the indirect nature of these

costs and the intangible aspects of the benefits.

The Report outlines some specific concerns

related to regulatory burden that were raised

in submissions, including issues such as

inadequate consultation, uncertain timing and

excessive prescription.

A key determinant of total regulatory burden

imposed by APRA on the financial sector is the

overarching approach to regulation and

supervision. APRA seeks to take a principles-based

and proportionate approach to its oversight of

financial institutions, which recognises that there

can be more than one method to effectively and

efficiently achieve a particular prudential

outcome. For example, APRA’s governance

standards allow tailored approaches for large and

small institutions and for different operating

structures, provided the institution can

demonstrate that the principal prudential

objective is achieved. Another example of this

proportionate approach is the ADI liquidity

requirements: smaller institutions are not

expected to be able to devote the same resources

to complex modelling as larger institutions, and

nor is this required to appropriately reflect the

risks in their business models.

Once a sound policy framework is established,

APRA is more likely to achieve effective prudential

outcomes through constructive and intensive

supervisory interaction with regulated institutions

on issues of concern, and through prudential

guidance rather than through the continued

addition of detailed rules. Current issues of

prudential concern – for example, housing

underwriting standards and group life insurance

risk – are being dealt with primarily by discussions

with, and detailed reviews of, institutions about

appropriate risk management, rather than

developing new regulations. APRA’s supervision-

led approach offers three key benefits to minimise

regulatory burden:

it allows for greater supervisory attention to

be targeted at issues and institutions of

greatest risk;

it avoids imposing regulatory cost where it is

not needed; and

it provides scope to meet regulatory

objectives in a manner best suited to the

size, nature and complexity of the

institutions concerned.


The regulatory structure is also a factor in driving

regulatory costs. Compliance with multiple sets of

regulatory expectations leads to excessive and

duplicative regulatory costs. Australia appears

relatively well placed in this regard. Prudential

supervision of ADIs, insurers and superannuation

funds is undertaken solely by APRA. As a result,

overlap with other Australian regulators is minimal

and respective roles are clearly delineated.54 In

contrast, in a number of other countries, two or

more domestic regulatory agencies have

prudential responsibilities relevant to the same

institutions. Examples include the multitude of

banking supervisors in the United States, the new

supervisory mechanism in the European Union,

and the joint supervisory responsibilities between

the prudential supervisor and the central bank

of Japan.

Costs and benefits

APRA is subject to the Government’s best practice

regulation process administered by the Office of

Best Practice Regulation. This process involves a

cost-benefit analysis of the impact of any proposed

new regulation (and alternatives) on different

groups in the Australian community and on the

community as a whole, culminating in the

publication of a RIS. Since this framework has been

in place, APRA has maintained full compliance

with the RIS requirements. Following recent

changes, all RISs must now specifically quantify

the costs of all new regulations to business,

not-for-profit organisations and individuals,

and must be at least cost neutral, as determined

using the Business Cost Calculator.

As part of the Government’s policy to boost

productivity and reduce regulation, APRA is

currently undertaking a project to identify areas

where regulatory cost savings for the industry and

APRA may be achieved, without jeopardising the

overall effectiveness of the prudential framework.

Working with input from industry, APRA has

identified a range of areas where refinements to

54 In particular, the Regulation Taskforce 2006, Rethinking

Regulation: Report of the Taskforce on Reducing Regulatory Burdens on Business investigated the issue of regulatory overlap between APRA and ASIC, and found very little in the way of duplicated or conflicting requirements. The recommendations of the Report, designed to help ensure this remained the case, have been implemented by the respective agencies.

the prudential framework may be able to be made

without unduly compromising sound prudent

outcomes. A prioritisation process is being

undertaken to identify specific options to pursue,

having regard to the extent of compliance cost

savings available, effort likely to be involved in

making any changes and the likely prudential

impact. APRA expects to be able to announce an

initial set of proposals in the near future.

The Productivity Commission’s Regulator Audit

Framework also provides useful guidance for

assessing the extent to which regulators are

imposing costs on regulated institutions.55 APRA

has provided input to the Government on

appropriate implementation of the proposed

framework for APRA and is working toward

implementing appropriate reporting on relevant

performance measures in this area.

APRA agrees with the Interim Report’s comment

that ‘[c]osts and benefits go beyond the content of

the regulation: how it is implemented also

matters.’56 APRA carefully considers the timing of

the implementation of new requirements on the

affected industries, and takes into account the

extent of change likely to be required by industry

to meet these requirements. Where new

requirements involve a significant learning or

adaptation process, APRA engages with the

industry from an early stage to ensure effective

implementation is achieved. Extended timeframes

for compliance are generally provided where many

institutions are materially affected by the

regulatory changes. Bespoke transitional

arrangements for specific institutions or segments

of an industry that are more materially affected

will be established where necessary. This was the

case, for example, for the implementation of

APRA’s reforms to life and general insurance

capital requirements, which involved significant

changes to practices and overall capital levels at

some particular institutions. On the other hand, in

the case of the Basel III capital requirements,

nearly all institutions were in full compliance with

the new requirements at the effective date. As a

result, there was no need for protracted

implementation timelines.

55 Productivity Commission 2014, Regulator Audit

Framework, March. 56 Financial System Inquiry 2014, Interim Report, July,

page 3-94.


Tailored approach for smaller ADIs

Submissions to the Wallis Inquiry indicated a desire

by credit unions and building societies to be held

to the same standards as banks. This was viewed

as critical to being seen to be of equivalent

financial strength, and to maintain competitive

neutrality. The Wallis Inquiry generally supported

this proposition, but nevertheless encouraged a

degree of flexibility in the prudential framework

to recognise that one size did not always fit all.

APRA’s principles-based prudential approach for all

APRA-regulated industries is specifically designed

to support tailored approaches for institutions of

different scale or with specific business models.

Across APRA’s prudential standards, there is

considerable scope for smaller institutions to

demonstrate their compliance using less complex,

more streamlined approaches. Some requirements

already contain explicit size-based gradations; for

example, a less sophisticated approach to the

Pillar 3 disclosure requirements for smaller ADIs

has been in place since the implementation of

Basel II. Small ADIs are also subject to a simplified

loan-loss provisioning methodology and reduced

regulatory reporting requirements. In some cases,

simplified or tailored approaches can be provided

through the exercise of supervisory discretion or

exemptive authority under prudential standards

(for example, exemption of some small ADIs from

the requirement for an institution to staff its own

internal audit function).

As part of its efforts to identify potential

regulatory cost savings, APRA is open to

considering options to simplify the prudential

framework for smaller ADIs. However, a graduated

approach should not lead to an overall weakening

of the prudential requirements applying to ADIs,

and should avoid creating the perception of a

‘second-class’ group of institutions.

Data collection

A modern economy requires considerable and

high quality data to facilitate informed and

effective public-sector policy decision-making and

efficient interaction with the financial sector.

In the context of total assets of APRA-regulated

institutions of $4.5 trillion, the total costs of

data collection are small relative to the costs

that would flow from APRA and other agencies

not having access to adequate, accurate and

timely data.

APRA is a central repository of statistical

information on the Australian financial system

and collects and publishes a broad range of

financial and risk data that are essential input to

its supervision of regulated institutions. In

addition, APRA collects data from APRA-regulated

and non-APRA-regulated financial institutions to

assist the RBA, the Australian Bureau of Statistics

and ASIC to fulfil their roles; APRA also collects

some data to fulfil international reporting

expectations of organisations such as the Bank for

International Settlements. Much of the data is

shared between agencies to reduce the reporting

burden on institutions.

APRA concurs with the need to regularly review

both data collection processes and the supporting

infrastructure. As part of its project to reduce

regulatory compliance costs, APRA will be

assessing whether its data collection processes

could be made more efficient. Consideration will

also be given to whether any current data

collections could be streamlined, such as through

less frequent or less detailed reporting.

The infrastructure that supports APRA’s data

collection, the electronic system ‘Direct to APRA’

(D2A) is now 15 years old. Despite being upgraded

over time, stakeholder feedback is that it is not as

easy to use as other more modern technology. D2A

has also become costly for APRA to maintain, and

is not well integrated with recent Government

initiatives. For example, D2A is Standard Business

Reporting (SBR) compliant, but SBR is not

integrated into D2A. Nor does D2A allow software

providers to access D2A from within their own

environment, which makes it difficult for these

providers to verify that their software works for

regulated institutions. APRA considers the future

life of D2A to be limited; any replacement data

collection system is likely to cost in the tens of

millions of dollars. While the benefits are likely to

be substantial, APRA does not currently have

funding for such a major capital project. APRA will

investigate potential replacement systems for D2A

when this becomes feasible.


Data reporting and publication

APRA regularly reviews its data reporting

requirements and publications. Typically, this

occurs as part of the implementation of broader

changes to the prudential framework. Over time,

prudential data collection needs change and

previously useful data can become obsolete. The

APRA project to reduce regulatory compliance

costs will systematically look at areas where

longstanding data collections can be scaled back or

ceased. APRA also has underway a wholesale

review of its ADI data collection, which may lead

to discontinuation of some data items where costs

of collection outweigh benefits for supervision

or other uses. Particular attention is being given

to data collections that do not have any

prudential purpose.

New or revised prudential data is often required,

however, as new industry trends emerge and

regulatory requirements change. Where new data

is considered necessary for prudential or other

purposes, APRA is mindful of existing reporting

requirements and the burden on regulated

institutions of introducing new or revised reporting

forms. In the case of the new reporting forms

required to support the implementation of the

Stronger Super reforms, for example, APRA had

regard to the existing suite of returns and chose to

phase in the new statistical returns in order to

reduce the burden on superannuation funds. In

response to industry concerns, APRA is reviewing

the initial suite of reporting requirements and is

currently undertaking consultation on proposals to

pare back the original proposals for select

investment option reporting.

APRA aims to ensure that all data it collects is

actively used and is useful, be it for prudential,

macroeconomic, industry or other purposes.

Prudential and other data is of considerable value

in understanding key industry trends and risks.

APRA generally supports making more of the data

it collects from regulated institutions publicly

available. Over the years, APRA has published an

increasing amount of prudential data. For

example, APRA has recently begun publishing

greater detail on aggregate property-related

exposures of ADIs. APRA has proposed to make

certain general insurance, life insurance and

superannuation data non-confidential and

therefore publicly accessible.57 APRA also plans to

introduce a new online data dissemination tool

that will enable enhanced access to data in a

manner that facilitates manipulation, visualisation

and analysis.

APRA has a legal obligation under the APRA Act to

protect confidentiality and privacy of information

it collects from regulated institutions, but has

authority to determine which information is not

confidential and can therefore be published.

Typically, industry submissions are very supportive

of publication of aggregate-level data; however,

institution-specific information is considered more

sensitive. This usually stems from concerns that

publication of some types of institution-specific

data could result in disclosure of confidential

business strategies or otherwise be of commercial

detriment to regulated institutions. APRA will

continue to work with the industry on expanded

access to regulatory data, and welcomes views

from the Inquiry on areas where additional

publication of regulatory data would be beneficial.

It needs to be acknowledged that publication

requires a high level of data reliability, requiring

greater resourcing for data quality validation at

both APRA and regulated institutions.

57 APRA 2013, Confidentiality of general insurance data

and changes to general insurance statistical publications, February, APRA 2013, Confidentiality of life insurance data and changes to life insurance statistical publications, February, and APRA 2013, Publication of superannuation statistics and confidentiality of superannuation data, November.


Prudential regulation of superannuation (page 3-103)



Align regulation of APRA-regulated superannuation trustees and funds with responsible entities and registered managed investment schemes.

In 1997 the Wallis Inquiry specifically reviewed the

appropriateness of prudential regulation of

superannuation funds. It recognised that

superannuation and managed investment schemes

were operationally equivalent in many respects,

but recommended that superannuation’s unique

characteristics continued to provide a case for

prudential supervision. These characteristics

included the compulsory nature of superannuation

savings, the lack of effective choice for a large

proportion of members, the long-term nature of

superannuation and the contribution of

superannuation to tax revenue forgone.

The Inquiry notes that these characteristics have

persisted, and APRA considers them to be of

greater significance given the continued growth

of superannuation and hence its importance in the

context of retirement income policy. Accordingly,

there is no strong case for change to this model.

Indeed, the costs and disruption that would flow

from such a change would be material and

would appear to significantly outweigh any

possible benefits.

The 2010 Cooper Review noted that due to its

compulsory nature, many members of

superannuation funds do not have the necessary

capabilities to make optimal decisions about their

investment strategies.58 The superannuation

system is complex and, unlike many investors who

choose to place funds in managed investment

schemes, many superannuation members either

choose not to monitor the performance of their

superannuation fund or do not possess the

necessary financial literacy to do so.

As the superannuation sector continues to increase

in size and complexity and members’ expectations

of achieving an adequate retirement income

increase, fiduciary duties for trustees will remain

high. A primary objective of APRA’s prudential

requirements and supervision is to ensure trustees

act appropriately and with members’ best

interests at the forefront of their thinking. APRA

seeks to promote safety and soundness through

trustee governance and risk management

practices, and competence and effectiveness of

the trustee board and senior management, to

enhance the likelihood that members’

expectations, and the Government’s retirement

income policy objectives, are met.

58 Super System Review 2010, Final Report – Part 1:

Overview and Recommendations, page 8.


A conduct regulation approach such as that

applied to managed investment schemes, with a

narrow focus on compliance with licensing and

disclosure requirements, would not provide an

adequate level of confidence that superannuation

trustees are operating their funds prudently and in

members’ best interests. As the Interim Report

notes, consumers have experienced higher levels

of failure from investing in managed funds that

were not subject to prudential oversight, including

failed agricultural and property development

schemes, as well as in other institutions subject

solely to conduct regulation.59

The benefits of APRA’s integrated supervision

approach further support continued prudential

regulation of superannuation. As noted in APRA’s

initial submission, over the past 17 years there has

been a marked growth in the size of financial

conglomerates: APRA-regulated subsidiaries of

large financial groups now make up nearly 40 per

cent of the total APRA-regulated superannuation

sector.60 Given the current trend of consolidation

within the financial sector, this share is expected

to increase further. APRA considers that there are

clear efficiency benefits from having an integrated

prudential regulator using similar supervision

techniques and broadly similar prudential

standards to oversee the superannuation activities

of financial conglomerates. In addition, integrated

supervision avoids the risk of regulatory ‘blind

spots’ with respect to the varied activities of

complex financial groups, including their

superannuation activities.

Prudential regulation does, of course, involve the

direct cost of APRA supervision. In 2013, the levy

on superannuation funds to fund APRA’s activities

was $38.4 million, or about 3.6 cents per $1,000 in

superannuation assets supervised. A decade

earlier, the levy equalled about 5.9 cents per

$1,000. This cost does not seem excessive,

particularly in the context of the low level of loss

or failure as a result of gross mismanagement or

fraudulent conduct for prudentially regulated

superannuation funds since APRA’s establishment.

59 As noted in the Interim Report, recent examples include

Storm Financial, Trio Capital, Opes Prime, Westpoint and Commonwealth Financial Planning.

60 APRA 2014, Financial System Inquiry Submission, 31 March, page 12.

Given the need for continued prudential regulation

of superannuation, the collapse of Trio Capital

highlighted a number of areas where the

legislative powers available to APRA could be

strengthened to reduce the likelihood of similar

issues occurring in future. Several such areas were

identified in a report by the Parliamentary Joint

Committee on Corporations and Financial Services

into that collapse, and related in particular to

licensing and changes of ownership and control.61

APRA has examined its legislative powers in

superannuation and identified three key changes

that would align its powers with those available in

other APRA-regulated industries:

a broad and robust power to give directions;

broader discretion to refuse an RSE licence

and powers to set licensing criteria; and

powers to approve changes in ownership and

control of RSE licensees.

APRA views it as important that these key changes

be implemented.62

Finally, while there is a strong case for the

prudential regulation of those superannuation

funds that are currently APRA-regulated,

that does not extend to self-managed

superannuation funds (SMSFs). As the members of

an SMSF are also its trustees (or directors of a

company that is the trustee), the interests of

members and trustees are naturally aligned. The

cost of prudentially regulating SMSFs would, simply

by virtue of the sheer number of such funds, be

substantial and significantly outweigh any

benefits. The current arrangement whereby

SMSFs fall outside the prudential perimeter is

therefore appropriate.

61 Parliamentary Joint Committee on Corporations and

Financial Services 2012, Inquiry into the collapse of Trio Capital.

62 Enhancements to APRA’s directions powers were included in the 2012 Government Consultation Paper titled Strengthening APRA’s Crisis Management Powers, but have yet to be implemented.


Retail payment systems regulation (page 3-106)



Consider a graduated framework for retail payment system regulation with clear and transparent thresholds.


Is there firm evidence to support opportunities for simplifying the regulatory framework for retail payment systems and participants?

What are practical and appropriate options to simplify the current regulatory framework for retail payment systems and participants?

In 2003, APRA established requirements for the

regulation of non-ADI credit card providers

(Specialist Credit Card Institutions, or SCCIs) in

support of policies for credit card scheme

participation administered by the RBA. SCCIs are

licensed as a class of ADIs subject to a less

comprehensive prudential regime. To date, use of

the SCCI regulatory regime has been minimal, with

only two providers currently licensed.

Earlier this year the Payments System Board

determined that the SCCI regime was no longer

necessary, and that participants in credit card

schemes should not need to be licensed by APRA.

APRA supports this approach, given the very

limited prudential risks inherent in credit card

issuing and acquiring businesses. APRA will work

with the RBA and the Government to implement

the necessary regulatory changes.

As described in the RBA’s March 2014 submission to

the Inquiry, regulation of purchased payment

facility (PPF) providers was mandated under the

Payment Systems (Regulation) Act 1998 as a result

of concerns expressed in the Wallis Report about

the potential growth of stored-value cards and

online payment systems with deposit-like

features.63 A Banking Act regulation was

established to prescribe that, in certain cases, this

activity constituted banking business and therefore

63 Reserve Bank of Australia 2014, Submission to the

Financial System Inquiry, March.

needed to be licensed and supervised by APRA. In

particular PPF providers that operate such that the

customer is able to obtain repayment of balances

on demand, and where the system is available on a

wide basis as a means of payment, are currently

considered to be banking business. APRA

established a PPF licensing regime to implement

this requirement; like SCCIs, PPF providers are

subject to a less comprehensive set of ADI

prudential requirements.

To date, stored-value cards and online stored-

value payment systems have not emerged as

strongly as anticipated in the Wallis Report. The

need for the PPF licensing regime has been very

low, with only one PPF provider currently licensed

by APRA. APRA concurs with the RBA’s March 2014

submission to the Inquiry that where customer

balances are not high, PPF regulation is largely a

consumer protection issue and that ADI-style

regulation may not be needed. APRA is open to

working with the Government and RBA to

achieve more targeted and streamlined

approaches in this area.


Operational independence (page 3-110)


Do Ministerial intervention powers erode regulator independence?

APRA’s effectiveness as a prudential regulator –

its ability and willingness to act – depends crucially

on having a clear and unambiguous mandate and

operational independence, a robust set of

prudential requirements, an active programme

of risk-based supervision, and adequate

staffing and financial resources to meet its

statutory objectives.

APRA agrees with the Inquiry’s conclusion that

independence of the financial regulators should be

maximised to the greatest extent possible, with

appropriate accountability mechanisms to provide

the necessary checks and balances.64 As noted in

APRA’s initial submission, the passage of time has

seen the imposition of constraints on its

prudential, operational and financial flexibility

that have eroded its independence. As a result, it

falls short of global standards in this area.

APRA’s initial submission noted two aspects of the

legislative framework under which APRA operates

that are important in this regard:

Changes to the APRA Act in 2003 diminished

the clarity around APRA’s prudential policy-

making authority. It is preferable that the law

clearly recognise APRA’s ability to set

prudential policy, within the bounds set out by

the APRA Act and relevant Industry Acts.

APRA’s policy-making role could also be

reflected clearly in the Government’s

Statement of Expectations (SOE) and APRA’s

Statement of Intent (SOI).


page 3-108.

The 2003 changes also made it easier for the

Minister to give a direction to APRA (although

not in relation to a particular entity). This

power, while not used to date, has been

identified by the IMF as potentially diminishing

the ability of APRA to carry out its supervisory

and regulatory functions effectively. While it

is accepted that the Government should have

a reserve power to override the decisions of

regulatory agencies, the framework under

which this power can be used is critical to

ensuring its presence does not erode

regulatory independence. The original model

for issuing directions to APRA was based on

those applying (and still applying) to the RBA.

A similar process has since been instituted

for the Future Fund in respect to its

investment directions.

Strengthening APRA’s independence in these areas

could be appropriately combined with

commensurate measures to improve transparency

with respect to how APRA considers and balances

its policy objectives, as discussed further below in

the section on accountability.


Budgetary independence (page 3-113)



Move ASIC and APRA to a more autonomous budget and funding process.

APRA supports the best case funding model set out

in the Interim Report, as well as the Inquiry’s

conclusion that current arrangements could be

enhanced to provide greater stability and certainty

year to year, and thereby promote greater

operational independence. A more autonomous

budget and funding process for APRA, together

with increased transparency and consultation

regarding how APRA proposes to utilise its

resources, would also be consistent with

recommendations made in the 2013 Australian

National Audit Office (ANAO) review of the current

levies process.65 The Interim Report proposed the

following model, which is consistent with the

approach put forward in APRA’s initial submission:

Industry and other stakeholders would receive

an opportunity to provide feedback on the

budget proposals and the level of APRA

resourcing proposed (there are a range of

mechanisms that could be instituted to give

effect to this).

A final budget and levies proposal would then

be submitted to Government, including a

summary of the feedback received from

industry and other stakeholders and APRA’s

response to these.

The Government would adopt the proposed

budget, and efficiency dividends would not be

applied to APRA.

65 Australian National Audit Office 2013, Determination

and Collection of Financial Industry Levies, ANAO Performance Audit Report no. 9.

APRA would also publish more detailed, and multi-

year, budget projections as a basis for the

consultation process.

A process along the lines set out above would

provide greater certainty and stability of APRA’s

funding from year to year. The enhanced external

consultation process would also drive greater

internal and external scrutiny of the allocation

of APRA’s resources across functions, and assist

APRA in identifying opportunities for efficiencies.

This would further strengthen transparency, and

hence APRA’s accountability, as discussed in the

next section.

The Interim Report also notes that a key principle

underpinning a best-case funding model for

financial regulators is that it promotes operational

independence. The enhanced accountability

framework that is proposed should reduce the

need for APRA to be subject to broader whole-of-

Government procurement and other requirements,

which are not always well-suited to the needs of

an agency of APRA’s scale and scope.


Accountability (page 3-117)


No changes to current arrangements.

Conduct periodic, legislated independent reviews of the performance and capability of regulators.

Clarify the metrics for assessing regulatory performance.

Enhance the role of Statements of Expectations and Statements of Intent.

Replace the efficiency dividend with tailored budget accountability mechanisms, such as regular audits and reviews to assess the regulators’ potential for savings.

Improve the oversight processes of regulators.

APRA is accountable for its activities and

performance through a wide range of existing

oversight mechanisms, including the following:

APRA is required to publish an Annual

Report, which provides a thorough account of

its activities each year. The Report is tabled

in Parliament and published on the

APRA website.

APRA makes regular appearances at Senate

Estimates, as well as ad hoc appearances

before other committees. It is proposed that

APRA will also make a regular half-yearly

appearance before the House of

Representatives Standing Committee on

Economics, on a similar basis as the RBA.

APRA receives an SOE from the Government

which sets out the Government’s expectations

about the role and responsibilities of APRA, its

relationship with the Government, issues of

transparency and accountability, and

operational matters to guide its activities. In

response, APRA issues an SOI to indicate how it

will meet the Government’s expectations.

APRA’s SOI provides details of its commitment

to effective and efficient delivery of its

activities and to ensuring that it operates in

accordance with relevant legislation and

Government requirements.66

66 The Treasury 2014, Statement of Expectations—

Australian Prudential Regulation Authority, and APRA 2014, Statement of Intent—Australian Prudential Regulation Authority, July.

APRA publishes an Annual Regulatory Plan that

sets out APRA’s current policy agenda and the

status of various policy initiatives.

APRA’s expense base is set annually by the

Government, and its budget is subject to

scrutiny by the Department of Finance.

APRA is subject to annual financial audits

by the ANAO, as well as occasional

performance audits.

APRA complies with the Government’s best

practice regulation process administered by

the Office of Best Practice Regulation, which

includes cost-benefit analysis and extensive

consultation on policy proposals.

APRA’s regulation-making power is in the form

of prudential standards, which are

disallowable instruments and therefore

subject to veto by Parliament.

APRA’s exercise of its supervisory powers is,

for the most part, done confidentially, but it is

ultimately subject to review by either the

Administrative Appeals Tribunal or the courts

under the Administrative Decisions (Judicial

Review) Act 1977.


In addition to meeting these requirements:

APRA senior executives regularly give speeches

and public presentations to explain APRA’s

current priorities and activities.

APRA commissions regular independent

surveys of key stakeholders to elicit their

feedback on its performance.

APRA is subject to independent reviews by

various international bodies, as detailed in

APRA’s initial submission to the Inquiry.

The outputs from these accountability and

oversight mechanisms, such as audit reports, RISs,

policy consultation responses and submissions,

speeches and stakeholder survey reports are

regularly published, along with other information

on APRA’s activities.

Given the desirability of strengthening APRA’s

operational and budgetary independence (as

discussed in the preceding section), additional

accountability mechanisms may be warranted to

ensure an appropriate balance between

independence and accountability is maintained.

However, in light of the extensive set of

accountability mechanisms already in place,

it is important that any additional measures

supplement, rather than duplicate, those already

in place.

To enhance the effectiveness of APRA’s

accountability arrangements, and the level

of transparency regarding APRA’s activities

and performance in the context of its

statutory mandate, APRA is considering a

number of additional measures that may be

appropriate, including:

APRA publishing its four-year Strategic Plan,

annual Operating Plan and annual budget and

three-year budget forecast as part of an

enhanced consultation process in relation

to APRA’s funding and the determination of

the annual industry levies (refer to the

previous section);

APRA commissioning additional periodic

independent reviews, by appropriately

qualified experts, of aspects of APRA’s

operations. Consistent with existing practice,

reports from those reviews and APRA’s

response would be made public. These reports

would also usefully complement the enhanced

budget-setting process described above;

enhancing reporting against key performance

measures relevant to APRA’s operations,

broadly consistent with the approach outlined

in the Productivity Commission’s Regulator

Audit Framework. APRA could also publish a

regular self-assessment against relevant

performance measures, consistent with the

Regulator Audit Framework;

APRA undertaking post-implementation

reviews at a suitable period after the

implementation of major policy reforms, to

assess the impact on industry and the

effectiveness of the reforms in achieving the

intended objectives; and

APRA enhancing its regular stakeholder survey

to cover a broader range of areas and issues

relevant to APRA’s performance, including in

key areas covered by the enhanced reporting

framework referred to above.

A number of these ideas are similar to those

suggested in the Interim Report, and are discussed

in more detail below.

Enhanced Statements of Expectations

and Statements of Intent

APRA concurs with the Interim Report’s

observation that the current SOE process could be

enhanced to provide stronger guidance on the

Government’s expectations about regulatory

outcomes to be achieved and metrics or

expectations for measuring performance.67 In

APRA’s case, a more explicit statement of the

Government’s tolerance for risk in the financial

system, and in particular the failure of a regulated

institution, would also help guide APRA’s

regulatory and supervisory activities. The SOE and

SOI should also be regularly updated (e.g. every

two to three years). Ideally, this would occur in

conjunction with the broader process outlined

above for publication of APRA’s Strategic Plans in

conjunction with consultation on


page 3-114.


APRA’s budget and funding. Such a process would

be consistent with the approach taken for the

Reserve Bank of New Zealand’s SOI, as referenced

in the Interim Report.68

Regulatory performance metrics

Despite the focus on regulatory failings as a result

of the global financial crisis, regulatory

performance measurement remains an under-

developed area. APRA is an active participant in

emerging international work on this topic, but

there are as yet no clear benchmarks that can be

gleaned from overseas experience. Evidence to

date suggests that Australia is at the forefront of

assessing and communicating its regulatory impact

and performance.

APRA already publishes a range of performance

indicators in its Annual Report, and is seeking to

provide greater transparency on how it

accomplishes its mission. Initiatives such as the

Productivity Commission’s Regulator Audit

Framework are useful developments in this regard.

As part of this initiative, APRA is working to

develop additional performance and efficiency

indicators. These may include, for example,

greater detail on supervisory activities and

decisions, and use of financial and staff resources.

Budget accountability mechanisms

APRA has in recent years been subject to general

‘efficiency dividend’ requirements under which

the Government has reduced agency funding with

the objective of driving efficiency savings and

improving its overall budget position. As noted by

the Inquiry, the efficiency dividend is a ‘blunt

instrument that is not appropriate for smaller

agencies with lower levels of discretionary

costs’.69 Efficiency dividends in an industry-funded

regulatory agency also make no contribution to the

Government’s budgetary objectives.

68 Reserve Bank of New Zealand 2014, Statement of Intent

for the period 1 July 2014 to 30 June 2017. 69 Financial System Inquiry 2014, Interim Report, July,

page 3-114.

As a result, APRA strongly supports a tailored

budget process that would result in greater

autonomy for APRA to determine its budget,

within agreed parameters and subject to industry

consultation and Government oversight, but

without the ad hoc imposition of efficiency

dividends and other blunt cost-saving directives.

As mentioned above, APRA is currently

undertaking a project to look at opportunities to

drive greater efficiency and effectiveness from a

supervision and operational perspective. Although

still early in the process, this exercise is likely to

yield a range of options to consider. Publication of

additional performance measures as discussed

above, as well as greater use of independent

reviews, would also support a more autonomous

budget process.

Independent reviews

APRA has been subject to a number of

independent reviews over the past decade on

various aspects of its performance. In the wake of

HIH Insurance’s collapse, APRA commissioned the

Palmer Review that prompted material changes to

APRA’s operations.70 Reviews undertaken in more

recent years by the IMF, FSB, and the Basel

Committee have provided objective and

independent assessments of APRA’s performance

against internationally accepted standards.71 APRA

has instituted many of the recommendations of

these reviews.

70 Palmer J. 2002, Review of the role played by the

Australian Prudential Regulation Authority and the Insurance and Superannuation Commission in the collapse of the HIH Group of companies.

71 Refer to APRA 2014, Financial System Inquiry Submission, 31 March, pages 64-66 for further details on these reviews.


APRA does not consider that independent reviews

need to be legislated, or be established as part of

a rigid whole-of-Government process. Rather the

need for, and scope of, external reviews could be

dealt with through an enhanced SOE and SOI

process. This allows the Government to exercise

appropriate oversight of the scope, frequency and

transparency of reviews, but in a manner that does

not jeopardise regulatory independence. It also

allows for reviews to be conducted in a manner

tailored to each agency’s circumstances, and

having regard to the timing and frequency of other

independent reviews that currently occur, such as

the IMF FSAP.

Given the specialist nature of much of APRA’s role

and activities, it is important that any independent

reviews are performed by suitably qualified

organisations or individuals who understand in

considerable depth the nature of the operations of

prudential regulators. Typically, this would require

current or former specialists from appropriate

overseas regulators or international organisations.

Existing domestic bodies, such as the ANAO, have

the expertise to undertake reviews of some of the

more operational aspects of APRA’s activities, such

as its financial and corporate activities. Even

reviews that are focused on assessing operational

efficiency, however, need to be undertaken by

parties with an adequate understanding of the

operations of a regulatory agency. As a result,

both the scope of these reviews and who would

perform them need to be carefully considered.

Improve oversight of regulators

The Interim Report notes that stakeholders have

raised suggestions for improving the oversight

processes for regulators and provides two

examples: establish an Inspector-General of

Regulation or establish a unified oversight

authority for financial regulators. The steps

outlined above to enhance APRA’s accountability,

including undertaking regular independent reviews

of APRA’s performance across a range of areas and

implementing the Regulator Audit Framework,

would be a preferable and more effective

approach to improve oversight.


Regulator structure and coordination (page 3-120)



Consider increasing the role, transparency and external accountability mechanisms of the CFR:

- Formalise the role of the CFR within statute.

- Increase the CFR membership to include the ACCC, AUSTRAC and the ATO.

- Increase the reporting by the CFR.

The Australian regulatory framework provides a

clearly defined mechanism for cooperation and

coordination between regulatory agencies. APRA

agrees with the Interim Report’s observation that

regulatory coordination mechanisms have been

strong, and that the CFR is a flexible and low-cost

approach to coordination.72

The focus of the CFR is financial stability, and

hence it is the focal point for ongoing interagency

work relating to strengthening crisis management

and monitoring systemic risks. The approach to

coordination has worked well and helped

contribute to Australia’s successful record of

interagency cooperation during the global financial

crisis. A more formalised approach, with the CFR’s

powers and functions defined in statute,

substantially risks blurring regulators’ existing

responsibilities and powers, and muddying their

accountabilities. On that basis, there is no strong

reason to change the current arrangements.

Given its primary focus on financial stability and

crisis management, there does not appear to be a

need, and it is unlikely to be an efficient use of

resources, to widen the permanent membership of

the CFR. The CFR can, as it already does, invite

other agencies to participate in meetings where

there are issues relevant to their responsibilities.


page 3-118.

In addition, APRA has a number of mechanisms

to promote inter-agency cooperation and

coordination with the Australian Competition and

Consumer Commission, Australian Transaction

Reports and Analysis Centre and the ATO. This

includes bilateral Memoranda of Understanding to

govern the exchange of information on mutual

issues, and established liaison meetings to

discuss financial sector policy and relevant

enforcement issues.

The CFR publishes key publications on its website,

and produced an Annual Report of its activities

from 1998 to 2002. Since 2003, summaries of the

CFR’s activities have been included in the RBA’s

Financial Stability Review, with many of these

issues also chronicled in CFR agencies’ own Annual

Reports. If the Inquiry formed a view that greater

reporting by the CFR was warranted, this is

probably best done through an expanded section

of the Financial Stability Review. Such an approach

would maintain the Review as the primary vehicle

for publishing the authorities’ views on financial

stability matters in Australia.


Regulator mandates (page 3-128)



Strengthen competition considerations through mechanisms other than amending the regulators’ mandates.

The Interim Report observes that the

regulators’ mandates and powers are generally

well defined and clear, but that more could be

done to emphasise competition.73 APRA’s approach

to balancing its objectives, including competition,

was discussed in its initial submission to the

Inquiry. While competition is vital to a healthy

financial industry, the idea that financial safety

and competition are mutually exclusive is short-

sighted. Strong prudential regimes make for

strong financial institutions and these, in turn,

make the most robust competitors through good

times and bad.

The Interim Report makes two suggestions to

strengthen regulatory consideration of competition

impacts that are relevant to APRA:

appointing an additional APRA Member, or

establishing another mechanism, to

specifically consider ‘the impacts of regulatory

intervention on competition’; and

requiring APRA’s Annual Report to include a

section on competition.


APRA does not support the suggestion to appoint

an additional APRA Member with a narrow

mandate. Under APRA’s current governance

arrangements, APRA Members operate

collaboratively and collectively in overseeing

APRA’s operations and taking prudential policy

decisions. All are accountable for considering and

balancing the entirety of APRA’s objectives.

Appointing a narrowly-focused Member with

unique responsibilities would create ambiguity in

APRA’s governance framework; it might also

potentially imply lessened responsibility of the

other Members with respect to competition.

A preferable approach, if needed, is to strengthen

the accountability mechanisms to demonstrate

how APRA considers all of its objectives. Ideas in

this area have been discussed in the earlier section

on accountability. Requiring expanded detail in

APRA’s Annual Report could be implemented, for

example, by including such a request in the

Government’s SOE for APRA.


Talent management (Interim Report page 3-128)


Review mechanisms to attract and retain staff, including terms and conditions.

As set out in APRA’s initial submission, in order to

be able to effectively perform its role, APRA needs

to be able to attract and retain suitably

experienced and qualified staff. The most critical

component of APRA’s work involves supervisory

judgement, and APRA and regulated institutions

benefit when these judgements are made by

professionals with a strong foundation of technical

skills and financial sector experience.

Typically, APRA recruits from the financial sector:

over the past five years, less than five per cent of

staff have been recruited from the core of the

Australian Public Service. Similarly, resigning APRA

staff tend to leave for financial sector roles. As a

result, since the sobering experience of the failure

of HIH Insurance, APRA has sought to maintain its

employment conditions relative to the broad

financial sector. Although APRA’s salaries are

generally below the levels available in the private

sector, overall working conditions along with the

experience and challenge that comes from working

in a prudential regulator has allowed APRA to

attract and retain experienced and skilled staff.

The current Government-wide enterprise

bargaining framework, and the constraints it

imposes on APRA’s ability to negotiate an

appropriate enterprise agreement with its staff in

a timely manner, is making it difficult to maintain

these relativities. Financial sector salaries are

growing in the order of 3-4 per cent per annum,

and unless APRA can over time broadly keep up

with this pace, it will be increasingly difficult to

maintain the quality of APRA’s workforce. The

current APRA employment agreement expired in

June this year and, due to the extensive approval

process required under the revised bargaining

framework, APRA has been unable to finalise an

enterprise agreement or provide any annual

general remuneration increase for staff. This is

already being reflected in rising turnover and

remuneration levels lagging targeted financial

sector benchmarks.

The greater budget autonomy discussed earlier

would be of limited benefit if it is not

accompanied by greater freedom to set

appropriate employment terms and conditions for

staff, within the constraints of the overall agreed

budget for APRA.


Chapter 8 of the Interim Report: Retirement income

The retirement income system (page 4-25)



Provide policy incentives to encourage retirees to purchase retirement income products that help manage longevity and other risks.

Introduce a default option for how individuals take their retirement benefits.

Mandate the use of particular retirement income products (in full or in part, or for later stages of retirement).

APRA agrees with the observation in the Interim

Report that the retirement phase of

superannuation is underdeveloped. As noted in the

Report, the ageing population presents a major

challenge for the financial system and a suitable

range of financial products and services is needed

to enable a greater number of individuals to

manage income and risks in retirement, as well as

the transition from work to retirement.

Critical to determining what the financial sector

can offer in the retirement phase is to have clarity

as to the overall objectives for the retirement

income system. These objectives should reflect

the need for retirees to have adequate resources,

either provided by government in a sustainable

manner or from private means, to provide for an

appropriate lifestyle in retirement.

Once the objectives are determined, all elements

of the retirement income system should be

considered in developing any proposals for

change. This includes the role of the Age Pension

and mandatory and voluntary superannuation

contributions, together with the relevant tax

and other policy settings, such as Age Pension

eligibility criteria. As noted in the Interim

Report, the current dominance of account-based

pensions over annuities is due to a range of

factors, and it is important that all of these are

considered when making any recommendations for

change. This is particularly important given the

other observation made by the Inquiry that

superannuation policy settings lack stability,

which adds to costs and reduces long-term

confidence and trust in the system.74


APRA does not propose to make any comments at

this stage on the specific policy options that are

put forward in this section of the Interim Report.

Before settling on specific details, it is critical that

there is holistic consideration of the policy settings

in both the pre-retirement and post-retirement

phases of the system so that a coherent,

sustainable and therefore stable retirement

income policy framework is able to be established

and effectively implemented. Recognising that

policy settings in the tax and transfer system are

outside the Inquiry’s Terms of Reference, APRA

would encourage the Inquiry to propose clear

parameters for the scope and nature of a

comprehensive process to consider and address the

important issues identified in its Report, and how

such a process may best be taken forward in the

context of other relevant Government initiatives

(such as the Tax White Paper) that are either in

train or planned.

Reflecting a likely objective of providing adequate

and sustainable income throughout retirement,

the policy framework should include mechanisms

that promote benefits being primarily taken as

income streams rather than lump sums. A focus on

retirement income adequacy and sustainability,

rather than wealth accumulation at retirement

date, is needed. No particular retirement income

products will, however, meet the range of needs

and adequately address the relevant risks for all

retirees throughout retirement. Accordingly,

a flexible and principles-based framework is

desirable that supports product development and

innovation and allows retirees to access a range of

suitable products that meet their needs as they

change throughout retirement.


If the Inquiry is minded to recommend default

options in the retirement phase of the system,

policy settings should encourage the development

of a competitive market in the provision of a range

of post-retirement default products. Existing

providers in the accumulation phase should not be

mandated to provide a post-retirement product.

For example, provision of post-retirement products

should not be required as a prerequisite for

authorisation to provide a MySuper product. Many

providers of accumulation products, including

MySuper products, may wish to provide post-

retirement options for competitive reasons,

however some may choose not to and some may

not have the capability to develop or provide the

type of products needed.

Retirement income products (page 4-31)



Take a more flexible, principles-based approach to determining the eligibility of retirement income products for tax concessions and their treatment by the age pension means-tests.

For product providers, streamline administrative arrangements for assessing the eligibility for tax concessions and age pension means-tests treatment of retirement income products.

Issue longer-dated Government bonds, including inflation-linked bonds, to support the development of retirement income products.


Would deferred lifetime annuities or group self-annuitisation be useful products for Australian retirees? Are there examples of other potentially suitable products?

If part of retirees’ superannuation benefits were to default into an income stream product, which product(s) would be appropriate?

Will the private sector be able to manage longevity risk if there is a large increase in the use of longevity-protected products? How could this be achieved?

Should Government increase its provision of longevity insurance? How would institutional arrangements be established to ensure they were stable and not subject to political interference?

What are some appropriate ways to assess and compare retirement income products? Is ‘income efficiency’ a useful measure?

As noted above, APRA supports the adoption of a

comprehensive and holistic approach to addressing

the issues identified through the Inquiry. Changes

to policy settings should be implemented in a

coordinated manner with a range of other

Government initiatives, including fiscal and

taxation policies, and in the context of broader

retirement income policy objectives that consider

the pre-retirement and post-retirement phases of

the system. In developing policy responses, APRA

generally supports the concept of more flexible,

principles-based approaches for assessing aspects

such as the eligibility of products for tax

concessions and their treatment in the Age Pension

means test. A principles-based approach is likely

to be more conducive to product development and

innovation over the medium term and enable

appropriate risk sharing between retirees and

product providers.


Although greater flexibility could be provided to

allow product development, it is important to

recognise that many retirement income products

will be long-dated and involve considerable levels

of risk to the providers, particularly where they

include guarantees. They should therefore only be

provided by entities which are able to manage

these risks and carry sufficient capital to provide

an adequate buffer against unexpected shocks.

Recommendations for the streamlining of approval

processes need to recognise that the ATO, APRA,

ASIC and Centrelink all deal with specific,

disparate and discrete areas of policy which

generally require stand-alone assessment. That

said, APRA supports effective utilisation of existing

mechanisms for cooperation between agencies,

such as Memoranda of Understanding, to enhance

the interaction between agencies and inter-agency

communication. This could include, for example,

‘round table’ discussions, at least in the early

stages of new product approval, with all the

regulators present, rather than separate meetings

with each agency.

Potential products

A suitable range of financial products and

services is needed to enable a greater number

of individuals to manage income and risks in

retirement and to help manage the transition

from work to retirement. In principle, both

deferred lifetime annuities (DLAs) and group

self-annuitisation (GSA) products could be

useful additions to the suite of products available

to retirees. The current dominance of account-

based pensions over annuities reflects a range of

factors including their flexibility, the perceived

lack of value provided by annuities and the ability

to rely on the Age Pension to help manage

longevity risk. It is important that all of these

factors are considered when making any

recommendations for change.

Demand for lifetime annuities has been low for

many years (though the market has shown signs of

growth recently). The reasons for this are

complex, but include perceived poor value,

possible loss of capital on early death and lack of

flexibility. DLAs may suffer from the same issues to

a greater or lesser extent, but this has not been

tested by the market. DLAs are not currently

available because of tax and other reasons.

Absent these impediments, DLAs could provide a

useful complement to account-based pensions as

they protect retirees against the risk of outliving

their retirement savings and provide a definite

time horizon over which to manage the use of

other assets to fund retirement. Behavioural biases

such as a desire for flexibility and relative

underestimation of life expectancy may keep

demand for DLAs relatively low in the absence of

compulsion. The cost and complexity of these

products will also present challenges to their

acceptance by retirees, particularly in the non-

advised sector.

Providers of DLAs would need to invest funds over

a long time horizon and, post the deferral period,

make payments for the remaining life of the

retiree at a rate guaranteed at the time the DLAs

were purchased. The provider may also guarantee

that payments will increase under an indexation

arrangement. The price of DLAs will therefore

reflect the significant uncertainty over the long

time horizon in respect of future investment (and

reinvestment) returns, mortality improvement

rates and, where relevant, the inflation rate and

the cost of capital required to be held against

these risks. Inflation creates considerable

uncertainty for product providers, especially if

matching risk-free assets are not available to

mitigate the risk. This is exacerbated in instances

where better-than-expected mortality

improvement lengthens the period over which

benefits are paid, thus increasing the exposure to

inflation risk. These risks therefore require careful

consideration of indexation mechanisms.

DLAs have achieved some popularity in the United

States market, though their attractiveness has

decreased in the low interest rate environment

that has been prevalent in recent years.

As outlined in the Interim Report, GSA products

allow pool members to share, but not completely

eliminate, longevity risk. Payments are designed to

be relatively stable but they are not guaranteed;

rather, they are adjusted to reflect actual

investment returns and mortality. The risk of an

individual outliving his or her savings is shared by

pool members, whereas the risk of improvements

in population mortality is factored into the initial

annuity rate. As the income levels provided

through GSA are not guaranteed, the level of


capital that would be required to adequately

support payments from the pool would be lower

(as compared to lifetime annuities or DLAs),

which may make such products more attractive

to issuers and, through the pricing of the product,

to retirees. Some of the factors noted above,

such as regulatory settings and behavioural

biases, are equally relevant for GSAs and would

also need to be addressed for any meaningful

market to develop.

As the Interim Report notes, retirees with

sufficient savings will typically best meet

their objectives by using a combination of

products. Innovation across a range of products

is likely if policy settings are adjusted to

remove impediments to product development.

Products that have developed in overseas

markets include variable annuities (which

provide investment flexibility and a choice of

guarantees), participating (with-profit) annuities,

and impaired life annuities. Other potentially

suitable products are likely to evolve – for

example, it is quite possible to develop

investment-linked lifetime annuities or DLAs,

which would provide longevity protection without

payment amounts being guaranteed.

The revised framework should be flexible and

focus on desired objectives of retirees in different

circumstances and stages of retirement rather

than being product-specific.

Longevity risk

A recent Joint Forum Report noted that longevity

risk is a major risk for the sustainability of

retirement income systems around the world.75

The ability of the private sector to manage

longevity risk will depend on a number of variables

including the extent of risk sharing between

retirees and product providers, the level of

demand for annuities, the availability of

reinsurance or other risk transfer mechanisms and

the availability of information to assist in

adequately pricing the risks.

Providers of immediate lifetime annuities and DLAs

must hold capital in respect of the longevity risk

assumed. Issuers of participating annuities must

75 Joint Forum 2013, Longevity risk transfer markets:

structure, growth drivers and impediments, and potential risks, December.

also hold longevity risk capital, though to a lesser

extent, due to the partial sharing of longevity risk

with the annuitants. Given the nature of the

financial promises being provided, these products

should only be issued by prudentially-regulated life

insurance companies.

With GSA products, payments are not guaranteed.

Longevity risk is pooled but it is not transferred.

A provider would need to have adequate policies

and procedures to appropriately manage the pool,

but would not necessarily need to be a life

insurance company.

As noted in the Interim Report, annuities are made

more costly by adverse selection. An increase in

demand for annuities leading to higher take-up

rates across the population could potentially make

annuities more affordable. This would also benefit

insurers, who would be able to make greater use

of population mortality studies in their pricing. A

market for index-based longevity swaps and other

types of protection would also be more likely to

develop, and this would assist the private sector in

managing longevity risk.

The Interim Report notes that reinsurers may be

reluctant to accept material longevity risk because

of significant uncertainty around future longevity.

Nonetheless, there is a reasonably healthy and

developing market for longevity risk transfer,

through both conventional reinsurance and

through, for example, longevity swaps. Medical

advances that increase the cost of longevity

protection may reduce the cost of other types of

insurance. Reinsurers can be prepared to accept a

transfer of longevity risk because their other types

of reinsurance provide a natural hedge against

longevity risk. Longevity swaps involve a series of

payments based on actual longevity with the

insurer being liable for payments based on pre-

determined longevity assumptions.

The availability of research into population

mortality improvement, including development of

models for predicting future mortality

improvement, would assist the private sector in

managing longevity risk. Extensive research exists

in the United Kingdom where annuitisation has

been compulsory, however, there is limited such

research so far in Australia.


Access to equity in the home (reverse mortgages) (page 4-33)


What, if any, regulations impede the development of products to help retirees access the equity in their homes?

The Interim Report notes that equity release

products provide benefits to consumers by

allowing them to access the equity of a property

while retaining ownership. The market remains

very small due most likely to the limited appeal of

this type of financing. APRA’s regulatory capital

framework for ADIs does not include any

regulations or constraints regarding the

development of products to help retirees access

the equity in their homes. APRA’s capital

framework requires ADIs to hold regulatory capital

commensurate with the risk of these exposures.76

76 APRA 2010, letter to all ADIs, Basel II: treatment of

reverse mortgages and shared equity mortgages, 5 July.


Chapter 9 of the Interim Report: Technology

Data security and cloud technology (page 4-58)


Communicate to APRA continuing industry support for a principles-based approach to setting cloud computing requirements and the need to consider the benefits of the technology as well as the risks.

Cloud computing technology offers many

potential benefits, not least in terms of

efficiency, innovation and productivity.

Applications utilising cloud computing technology

may form an integral part of a financial

institution’s core business processes, including for

both approval and decision-making purposes, and

can be material and critical to the ongoing

operations of the institution. Key prudential

concerns regarding cloud computing relate to a

regulated institution’s ability to continue

operations and meet core obligations following a

loss of cloud computing services, confidentiality

and integrity of sensitive (e.g. customer) data and

compliance with legislative and prudential

requirements. APRA’s requirements are technology

neutral as cloud computing is treated in the same

manner as other business processes.

APRA has no specific prudential requirements

regarding cloud computing, although the principles

in the prudential standards and guidance material

related to outsourcing and business continuity and

the guidance on the management of security risk

in information and technology are pertinent. By

way of example, a key requirement of Prudential

Standard CPS 231 Outsourcing is for an ADI or

insurer to have a Board-approved policy relating to

outsourcing of material business activities, the

contents of which, beyond certain minimum high-

level requirements, are for the regulated

institution to determine. The same prudential

concerns apply to cloud computing technology

involving a third party as apply to any material

outsourcing arrangement. Under this approach

APRA seeks to ensure that a regulated institution

adequately understands and manages the risks

associated with outsourcing, given the nature of

the solution and the benefits anticipated.

The business continuity management requirements

are similarly high-level and apply to all business

processes, including those utilising cloud

computing technology.

APRA will consider whether any further guidance is

required by regulated institutions specifically on

the use of shared computing services including

cloud solutions. The development of any further

guidance would be subject to consultation and,

among other things, would aim to clarify APRA’s

expectations regarding the use of shared

computing services such that the benefits can be

obtained while the risks are minimised.


Chapter 10 of the Interim Report: International integration

Impediments to financial integration (page 4-88)


What are the potential impediments to integration, particularly their relative importance, and the benefits to the broader Australian economy that can be demonstrated if they were removed?

The Interim Report notes a number of

impediments to greater integration that have

been identified in submissions, many of which

have some relevance to APRA. These include

ownership restrictions, licensing processes, and

aspects of the prudential settings. APRA welcomes

the Interim Report’s observation that efforts to

drive greater financial integration should not be at

the cost of appropriate standards for financial

stability and conduct.

The impact of APRA’s prudential settings on the

international competitiveness of Australian ADIs

was addressed in APRA’s initial submission. It notes

that ‘there is little evidence from the crisis that

APRA’s approach penalised ADIs in Australia in

raising equity capital, accessing wholesale funds at

competitive rates or maintaining their credit

ratings. The opposite was more likely the case.’77

One particular aspect of prudential settings that

has been raised in this respect is the lack of

comparability of capital ratios across different

jurisdictions. This issue is discussed more fully in

APRA’s response to Chapter 5 of the Interim

Report. In short, APRA does not consider that this

issue has been an impediment to international

competitiveness. The best approach to addressing

the issue of international comparability of capital

adequacy ratios, without compromising the

veracity of the measure, is through disclosure of

the impact of APRA’s policies.


31 March, page 80.

Another aspect noted in the Interim Report

concerns the treatment within the capital

framework of minority investments in offshore

financial institutions. It has been longstanding

policy in Australia that ADIs’ holdings of other

ADIs’ capital instruments are deducted from

capital for the purpose of calculating capital

ratios; the policy predates the creation of APRA,

having been established by the RBA almost 25

years ago when it had the responsibility for bank

supervision.78 This approach is based on the

fundamental principle that regulatory capital

cannot be relied upon more than once in the

financial system to absorb losses.

As a consequence, capital invested in an

offshore bank must be funded by shareholders,

rather than depositors or other creditors, of the

investing ADI. To do otherwise would mean ADIs

were able to include the invested capital, but not

the associated risks that capital is supporting,

within the calculation of their capital ratios. In

other words, capital would be double counted.

APRA’s approach also helps insulate the domestic

business from the risks in investing in offshore

financial institutions; historical experience

suggests these are invariably riskier than domestic

businesses where ADIs are likely to enjoy their

greatest comparative advantage relative to

foreign competitors.

78 Reserve Bank of Australia 1990, Press Release: Capital

Adequacy: Bank’s Holdings of other Bank’s Capital Instruments, 90-24, 27 September.


The Interim Report also refers to the costs and

requirements associated with licensing, and

ongoing compliance costs, for foreign financial

institution entrants to the Australian financial

system. Anecdotal evidence suggests that APRA

may take a more rigorous approach to licensing

new ADIs and insurers, relative to some other

jurisdictions. However, there is no evidence that

APRA’s more rigorous approach is hindering foreign

access. Between 2003 and 2013, APRA granted 72

new licences, many to foreign financial

institutions, particularly in the banking sector.

High entry standards, particularly for entrants into

retail markets, are a key plank of APRA’s

prudential framework. APRA does not grant a

licence without a careful review of the applicant’s

capacity to manage a regulated business in

Australia. This process often takes some months

and numerous interactions with the institution. It

would not be in the interests of a stable financial

system, or of the community, for APRA to provide

easier access to the Australian market if this were

to lead to unsuitable entities operating as an ADI

or insurer in the Australian financial system. This

could also impair the level playing field with

established ADIs or insurers.

APRA is considering whether a more graduated

approach to licensing may be warranted, with a

view to achieving a more efficient and effective

process for both applicants and APRA. This may be

particularly appropriate for established foreign

institutions with a demonstrated track record of

successful international operations and that are

based in jurisdictions considered compliant with

international standards and equivalent to APRA in

terms of supervisory oversight. APRA notes that

the Bank of England recently adjusted the

requirements for firms entering into the banking

sector following a similar review.79

79 Bank of England and Financial Services Authority 2013,

A Review of Requirements for Firms Entering Into or Expanding in the Banking Sector, March.


Cross-border regulatory settings (page 4-97)


Improve domestic regulatory process to better consider international standards and foreign regulation — including processes for transparency and consultation about international standard implementation, and mutual recognition and equivalence assessment processes.


What changes can be made to make implementing international standards more transparent and otherwise improved?

What improvements could be made to domestic regulatory process to have regard to foreign regulatory developments impacting Australia?

Are there priority jurisdictions and activities that might benefit from further mutual recognition or other arrangements? What are the identified costs and benefits that might accrue from such an arrangement?

The existing consultation process for the

development and implementation of prudential

standards and related requirements allows for

stakeholders to provide feedback at both the

international negotiation stage and at the national

implementation stage. For example, the Basel III

capital framework was subject to international

consultation in 2009 and 2010, including a

comprehensive quantitative impact study (QIS) in

2010.80 Australian stakeholders provided feedback

during the international consultation process, and

the five most internationally active Australian

banks participated in the comprehensive QIS. APRA

also held a number of meetings with institutions

and participated in public forums in Australia on

Basel III. There was considerable transparency

about the direction and potential impact of the

planned policy changes. APRA has not, however,

traditionally taken an active role in alerting

domestic institutions to international policy

consultations. APRA would be open to more

actively promoting the opportunity for Australian

industry to contribute to international policy-

setting discussions if it was considered this would

be beneficial to increasing Australia’s ‘voice’ in

the process.

80 Refer for example to Basel Committee on Banking

Supervision 2009, Strengthening the resilience of the banking sector – consultative document, December, and Basel Committee on Banking Supervision 2010, Results of the comprehensive quantitative impact study, December.

For the Australian implementation of

internationally developed standards, APRA follows

an identical consultation and implementation

process to that which is used for proposals

developed domestically, including compliance with

the Government’s enhanced Regulatory Impact

Analysis requirements and Regulatory Burden

Measurement framework. This process is described

in APRA’s initial submission to the Inquiry.

The Interim Report suggests that Australian

representatives on international standard-setting

bodies need to have regard for whole-of-

Government objectives. Indeed, this is already

explicitly required of APRA as set out in the

recently updated SOE: ‘[t]he Government…

considers it important that prudential regulation,

and APRA’s standards and practices, support

Australia’s financial sector in globally integrated

markets through implementation of relevant

international standards in a manner that is

appropriate for our domestic circumstances.’81

This is also reflected in APRA’s responding SOI.82 As

an example of alignment with whole-of-

Government objectives, the Basel III framework

was developed following G20 recommendations on

strengthening financial supervision and regulation

which were endorsed by the Australian

81 The Treasury 2014, Statement of Expectations—

Australian Prudential Regulation Authority, page 3. 82 APRA 2014, Statement of Intent—Australian Prudential

Regulation Authority, July.


Government.83 APRA briefs the Government,

through its regular liaison arrangements with the

Treasury, on material international developments

with which it is engaged.

While internationally agreed standards necessarily

provide a basis for the proposed domestic policies,

APRA can and does consider the full range of

options available within the international

standards to ensure the implementation is

appropriate for Australia. In many cases,

APRA negotiates for inclusion of these options

at the international standard-setting bodies.

The Basel III liquidity reforms are a recent

important example where Australia successfully

influenced the international outcome by ensuring

the final standard acknowledged Australia’s

particular domestic circumstances. This outcome

was critical for ensuring Australian ADIs,

particularly those that are internationally active,

could continue to claim they are compliant with all

international minimum standards.

Mutual recognition

In the banking sector, APRA adheres to the

longstanding Principles for the Supervision of

Banks’ Foreign Establishments developed by the

Basel Committee. These principles clarify the

relative responsibilities of home and host

regulators of bank branches, subsidiaries and

joint ventures. The overarching premise is that

both the home and host supervisor have their

own responsibility to satisfy themselves of the

adequate supervision of the branch, subsidiary

or joint venture. There is no direct equivalent to

these specific Basel Principles for the insurance

sector. APRA takes account, however, of the

IAIS’s Insurance Core Principles when determining

its prudential requirements and supervision

approach for insurance branches, subsidiaries

and joint ventures.

83 G20 2009, London Summit—Leaders’ Statement, April.

A particular challenge of prudential regulation is

that the costs of failure are principally borne by

the host regulator’s jurisdiction, and host

supervisors are ultimately accountable to domestic

depositors and policyholders (and taxpayers).

This limits APRA’s ability to rely solely on home

regulators’ assessments of the financial adequacy

of local establishments of foreign banks or insurers

– just as foreign regulators are unable to rely

entirely on APRA’s supervisory assessments of

Australian institutions operating offshore.

APRA has participated in various efforts over

the last few years to enhance international

cooperation and coordination, for example

through supervisory colleges in which national

supervisors of internationally active regulated

groups participate.

Although APRA is limited in its ability to rely on

home regulators’ prudential regulation, it has

some scope to reduce compliance costs for

internationally active institutions. Australia’s

compliance with global standards provides a basis

for prudential regulators abroad to permit

Australian regulated institutions to operate in

some overseas jurisdictions, as well as under

certain mutual recognition regimes. A recent

example, highlighted in APRA’s initial submission,

is the new swap dealer requirements issued by the

United States Commodity Futures Trading

Commission that apply to those Australian ADIs

active in the American derivatives markets.84 The

Commission has granted ‘substituted compliance’

on the basis of the Australian regulatory

framework, allowing Australian ADIs to avoid

duplicative and costly regulation. A second

example relates to Solvency II, an upcoming

European regulatory framework for insurers. APRA

is engaging with European insurance regulators in

an effort to ensure that the Australian framework

is deemed equivalent to Solvency II, thereby

reducing the compliance burden on Australian

insurers with European operations.

84 Commodity Futures Trading Commission 2013, CFTC

approves comparability determinations for six jurisdictions for substituted compliance purposes, 20 December.


Coordination of financial integration (page 4-101)



Amend the role of an existing coordination body to promote accountability and provide economy-wide advice to Government about Australia’s international financial integration.


Have appropriate elements been put forward for an effective coordination body?

What role should industry play in any new coordination body, including its funding?

APRA considers that the existing coordination

arrangements have been effective with respect to

international aspects of prudential regulation. The

CFR and industry bodies such as the Financial

Sector Advisory Council (FSAC) are the appropriate

forums to provide the Government advice about

international financial integration as relevant to

the agencies’ respective mandates:

APRA briefs the Government, through its

liaison with the Treasury, on material

international developments that it is

involved in;

industry is provided with ample opportunity to

comment on policy formulation with respect

to international standards; and

industry has the opportunity through

existing industry bodies to provide input to

Government about where the Government’s

engagement efforts are most required or

best directed.

The current arrangements are further supported by

the Government’s recently updated SOE and

APRA’s SOI, which clearly outline the

Government’s expectations and APRA’s intent,

respectively, regarding APRA’s role in supporting

international financial integration.

APRA views the current Charter of the CFR as

appropriate. Expanding its role to explicitly

encompass international integration could distract

from its primary financial stability coordination

role. Given the FSAC’s focus on business

facilitation, it may be an appropriate body to

provide the Government with advice on

international integration issues.

Financial system inquiry Prudential Regulation Authority 4 APRA’s response to the Interim Report...

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